Monday, October 26, 2009

Patrick Byrne To Tough It Out With SEC Over GAAP Violations

Apparently, Overstock.com (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 Overstock.com 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, Overstock.com 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 Overstock.com's SEC filing. In addition, PricewaterhouseCoopers (PWC), Overstock.com's former auditors, consented to the company using flawed financial reports in its SEC filing. See below:

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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 Overstock.com, 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, Overstock.com'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 Overstock.com 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, Overstock.com 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 Overstock.com 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 Overstock.com to underbill earned income due from its fulfillment partners for offsetting costs and reimbursements. Overstock.com 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, Overstock.com 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, Overstock.com 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 Overstock.com 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).

Overstock.com's phony "gain contingency" excuse

After my early blog posts (here and here) detailing Overstock.com'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 Overstock.com 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."

Overstock.com 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.

Overstock.com 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: Overstock.com 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, Overstock.com'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, Overstock.com'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.

Overstock.com 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”). Overstock.com cannot defer income from underbilling its fulfillment partners to future accounting periods.

New Evidence of a botched audit by PWC and Overstock.com'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, Overstock.com 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 Overstock.com 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, Overstock.com failed to consider subsequent corrected billings to and collections from its fulfillment partners. Overstock.com'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 Overstock.com’s subsequent events disclosure in Q2 2009 is new required disclosure under SFAS 165. In any case, Overstock.com 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. Overstock.com’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 Overstock.com restating financial reports to correct its GAAP violations?

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.

Friday, October 09, 2009

Overstock.com CEO Patrick Byrne Is In a Very Sour Pickle

Overstock.com CEO Patrick Byrne is in a pickle or let’s just say that he is in a sour pickle. He has to make key decisions within the next weeks, before issuing his Q3 2009 financial reports, on how to handle certain financial reporting violations uncovered by this blog and now being investigated the Securities and Exchange Commission. As a result of my forensic accounting analysis, the SEC took the highly unusual step of bravely restarting its investigation of Overstock.com’s financial reporting violations, after dropping a previous investigation in June 2008 (details here).

My forensic accounting report to the Securities and Exchange Commission

In my open letter to the SEC, I detailed how Overstock.com failed to comply with Generally Accepted Accounting Principles (GAAP) in correcting its customer refund and credit errors and improperly created a "cookie jar reserve" to materially inflate reported earnings or reduce losses in future reporting periods (details here).

In October 2008, Overstock.com 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 Overstock.com restated its financial reports due a violation of GAAP.

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

In effect, Overstock.com 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 Overstock.com to report its first quarterly profit after a string of 15 consecutive quarterly losses and beat mean analysts’ consensus expectations for earnings per share.

Patrick Byrne’s choices

When Overstock.com issues its next financial report (due in a few weeks), the company can either restate its affected prior financial reports to properly reflect income from underbilling its fulfillment partners as it was earned in those periods or the company can tough it out and wait for the SEC or Grant Thornton (new auditors) to force a restatement of its financial reports.

If Patrick Byrne chooses to restate financial reports

If Overstock.com restates its financial reports it will be the third time in three years that the company had to correct financial reports due to violations of GAAP: (1) inventory accounting error - Q1 2002 to Q3 2005, (2) customer refund and credit error – Q1 2003 to Q2 2008, and (3) underbilled income from fulfillment partners – Q1 2003 to Q2 2009. Patrick Byrne will have the unique distinction being the CEO of a company that restated financial reports from overlapping prior accounting periods three times: Q1 2003 to Q3 2005.

I have no doubt that Patrick Byrne will continue to falsely claim it’s all an honest mistake (See Gary Weiss Blog, here). However, Overstock.com was notified by me of its GAAP violations starting in January 2009 and the company deliberately failed to act on it. Instead, I was viciously smeared by Patrick Byrne during earnings calls (Q4 2008, Q1 2009, and Q2 2009).

Patrick Byrne sent his paid internet stalker Judd Bagley to threaten me into settling my divorce case with my ex-spouse and smear me on the internet as retaliation for my exposure of Overstock.com's GAAP violations.

Another paid henchman used by Patrick Byrne to smear his critics is Mark Mitchell, a former Columbia Journalism Review (CJR) reporter who left his job under a cloud, when serious questions were raised about his journalistic integrity and ethics. In Byrne's Deep Capture blog, Mitchell claimed:

Antar writes with almost daily regularity that Deep Capture reporter Patrick Byrne is running a fraudulent company (Overstock.com), though he has produced nothing to support his claims, and every reputable person who has examined his arguments has concluded that they are absurd.

Yes, I do believe that Patrick Byrne has committed securities fraud. However, contrary to Mitchell's claim that I have "produced nothing" to support my claims, my blog has thoroughly documented false and misleading financial reporting by Overstock.com and lies to investors by Patrick Byrne dating back some ten years (some details, here).

In fact, every single financial report issued by Overstock.com, since its inception, has initially violated GAAP or other SEC disclosure rules. Only certain disreputable members of the management team running Overstock.com have disputed my findings. The SEC apparently agrees with me and not Byrne or Mitchell and it has restarted its investigation of Overstock.com.

If the SEC did not re-start its investigation of Overstock.com, I doubt that the company on its own would ever restate its improper financial reports to properly comply with GAAP as I have called for in my blog. For example, it took me a year of blogging and letter writing to Overstock.com and the SEC to push the company into properly complying with SEC Regulation G governing non-GAAP financial measures such as "Earnings before interest, taxes, depreciation, and amortization" or EBITDA (details here and here). During that time, Patrick Byrne, current company President Jonathan E. Johnson, and former CFO (now demoted) David Chidester falsely claimed that Overstock.com's improper EBITDA measure complied with Regulation G. However, Overstock.com finally changed its improper disclosures to comply with Regulation G and I was proven right.

If Patrick Byrne chooses to tough it out

If Overstock.com is willing to take the risk of an SEC enforcement action to compel the company to correct its financial reports, the company will face almost certain sanctions from the SEC for delaying its restatements. According to a paper issued by major securities law firm Paul Weiss:

Waiting for the SEC to force disclosure of accounting irregularities and making misleading statements to the press during an investigation in respect to the underlying focus of the investigation...all have the potential to result, and have in fact resulted, in significant penalties.

Paul Weiss specifically cited the SEC investigation of Dynegy (See page 3 and 4).

Patrick Byrne’s denials of wrongdoing and at the same time vilifying me in various earnings calls (Q4 2008, Q1 2009, and Q2 2009) and false and misleading statements to the press such as to Crain’s New York Business (subscription required), Deseret News, and the Salt Lake Tribune make him subject to stiff SEC sanctions. For example, Patrick Byrne told the Deseret News:

Byrne doesn't think Antar should get his hopes up as the restatements involve a trio of bookkeeping mistakes that when added and subtracted together decrease the company's bottom line by a mere $2 million against a total of $5 billion that was originally reported.

As Gary Weiss reported in his blog:

Byrne is obscuring the issue. All accounting errors cancel out over time (any forensic accountant can tell you about the double down effect-–you have to commit twice the fraud to maintain the fraud). It’s the timing of the accounting errors and their impact of quarterly results that counts – the "cookie jar reserve" that Sam has described in his blog. That's what has impacted the bottom line in several quarters.

For example, Overstock used smoke and mirrors to turn a fourth quarter 2008 loss into its "first quarterly profit in sixteen quarters." Didn't happen. Byrne's trying to portray this deliberate chicanery as "carelessness." Except that it was totally deliberate. Byrne has been on notice about these GAAP violations all along.

If anything, Patrick Byrne's actions reflect his deliberate intent to avoid following GAAP and SEC disclosure rules.

Issues with new auditors

Overstock.com’s new auditors, Grant Thornton, faces a thorny issue, too. The former auditors, PricewaterhouseCoopers signed off on Overstock.com’s 2008 financial reports, but failed to require Overstock.com to restate prior financial reports to properly reflect when underbilled income was actually earned from its fulfillment partners. Overstock.com’s GAAP violations in 2008 caused material errors in 2009 financial reports that Grant Thornton must audit. I doubt that Grant Thornton will go out on a limb and risk issuing a clean audit opinion without Overstock.com restating financial reports to correct its GAAP violations.

A CEO and company that apparently is unwilling to abide by the rules

Patrick Byrne once said:

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.

To this day, Overstock.com and its CEO Patrick Byrne were never about GAAP or following SEC disclosure rules such as Regulation G governing non-GAAP accounting measures such as EBITDA. So far, the company has restated its financial reports two times due to GAAP violations and an SEC Division of Corporation Finance review found that all financial reports from the company's inception to Q2 2008 failed to follow GAAP in reporting revenues. Financial reports from Q1 2003 to Q2 2009 must be restated to properly reflect when income was earned from underbilled fulfillment partners.

From Q2 2007 to Q2 2008, Overstock.com materially overstated its financial performance by using a non-compliant EBITDA in violation of SEC Regulation G. Patrick Byrne had said above that, "I don't believe in EBITDA. If somebody talks EBITDA, put your hand in your wallet: they're a crook." Overstock.com not only used EBITDA in its financial reports, it also misused EBITDA by excluding certain items from the calculation in violation of SEC Regulation G. Therefore, Patrick Byrne is a self-defined "crook" and a violator of securities disclosure rules.

In every single period of its existence, Overstock.com has issued financial reports that at least initially violated GAAP and other SEC disclosure rules. Meanwhile, Overstock.com has lost money in every single year of its existence while taking advantage of gullible investors by raising capital and issuing phony financial reports. In recent quarters, Overstock.com made $5.7 by buying back debt at a discount (less than face value) from unfortunate investors who relied on financial reports that failed to follow GAAP and SEC disclosure rules. Just about the only thing that Patrick Byrne is "about" is issuing phony financial reports, while taking money from his investors to finance a company that has never made money in any year.

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. The Paul, Weiss law firm was Crazy Eddie's outside corporate counsel. I scammed them, too.

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.

Wednesday, October 07, 2009

Crain's New York Business: Crazy Like a Fox - Aaron Elstein Interviews Me

The interview is available on newsstands or it can be downloaded from's Crain's New York Business with a trial subscription here. You can also read the article in Investment News (Crain's sister publication) here.

Here are some quotes:

"Guess who's tipping off the SEC on alleged accounting frauds? None other than the guy who cooked the books at Crazy Eddie...."

"Despite his felonious past, Sam Antar has earned credibility with law enforcement officials. He’s spent much of the past decade talking to the FBI, the Justice Department, the IRS, accounting students and business groups, explaining how Crazy Eddie fooled auditors for so long.The former CPA says he feels bad about what he did and wants to help overmatched investigators as they try to root out savvy fraudsters."

The article also discusses how I exposed Overstock.com's "cookie jar" reserves that violate Generally Accepted Accounting Principles (GAAP). Based on my forensic accounting analysis, the Securities and Exchange Commission took the very usual step of re-opening an investigation of financial reporting irregularities at Overstock.com (NASDAQ: OSTK) after dropping a previous investigation just fifteen months earlier in June 2008. See my previous blog post here.

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.