Thursday, November 26, 2009

Open Letter to the Securities and Exchange Commission (Part 4): Patrick Byrne Ignores Real Issues As He Vilifies Grant Thornton

Updated for two additional notes to the SEC at bottom of post

To the Securities and Exchange Commission:

Recently, Overstock.com (NASDAQ: OSTK) CEO Patrick M. Byrne has engaged in a vile public denunciation against Grant Thornton, the company's former auditors. On November 24, 2009, Overstock.com issued a press release disputing allegations by Grant Thornton that it did not approve the company recognizing the Q1 2009 recovery of a 2008 $785,000 overpayment to a fulfillment partner as income in 2009. Embittered CEO Patrick Byrne told the Salt Lake Tribune:

We refuse to knuckle under the SEC's and Grant Thornton's insistence that we abandon generally accepted accounting principles.

I am not surprised by Patrick Byrne's desperate lies given that every single financial report issued by the company since its inception has at least initially failed to comply with Generally Accepted Accounting Principles (GAAP) and SEC disclosure rules. Patrick Byrne, former CFO David Chidester, and present CFO Steve Chesnut have all signed Sarbanes-Oxley certifications that later turned out to be false. Likewise, every audited financial report certified by Grant Thornton's predecessor auditor PricewaterhouseCoopers (PWC), at least initially turned out to flawed. Instead complying with GAAP and SEC disclosure rules, the company vilifies regulators like the SEC, its critics such as myself, others, and now Grant Thornton.

No matter what excuse Overstock.com makes up to defend its 2008 financial reporting, SEC Staff Accounting Bulletin No. 99 on Materiality makes it clear that:

Registrants and auditors also should consider the effect of misstatements from prior periods on the current financial statements.

Despite pressure from its former client Overstock.com, Grant Thornton appropriately recommended that Overstock.com restate its 2009 financial reports because an accounting error originating in 2008 materially overstated the company's financial performance in Q1 2009. Instead, Overstock.com fired Grant Thornton, rather than restate its financial reports to comply with GAAP. Grant Thornton, unlike Overstock.com has acted responsibly based on new information it obtained during the course of a probe by the SEC Division of Corporation Finance.

The other main issue is that Overstock.com improperly moved income earned from underbilled fulfillment partners in prior reporting periods (Q3 2008 and before) to future reporting periods (Q4 2008 and later). In effect, Overstock.com established a "cookie jar" reserve to materially overstate its financial performance in future reporting periods in violation GAAP and SEC disclosure rules.

In my fourth open letter, I will discuss the current relevant issues and as usual I may have to repeat past issues to adequately explain what is going on now.

Note: Enclosed are links to my first, second, and third open letters to the SEC. Each letter is based on Overstock.com's deliberately vague, incoherent, and inconsistent, and often contradictory disclosures at the time each one was issued.

Background: Where this all started

In October 2008, Overstock.com restated its financial reports from Q1 2003 to Q2 2008 due to customer refund and credit errors. It was the second time in two years that Overstock.com restated its financial reports due to GAAP violations. In fact, financial reports from Q1 2003 to Q3 2005 were restated twice: in 2006 due to inventory accounting errors and in 2008 due to customer refund and credit errors.

However, the October 2008 restatement did not include corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts. In other words, Overstock.com should have gone back and corrected or restated its financial reports to reflect income already earned from offsetting costs and reimbursements due from its fulfillment partners, less a reasonable estimate for uncollectable amounts. (See SFAS No. 154 and SFAS No 5 paragraph 1, 2, 8 and 23). It didn’t.

Instead, Overstock.com improperly deferred income that it earned but underbilled its fulfillment partners during prior reporting periods (Q3 2008 and before) to by moving such income to future reporting periods (Q4 2008, Q1 2009, Q2 2009, and Q3 2009). In other words, Overstock.com took income that should have been reported in prior reporting periods (Q3 2008 and before) and moved it to future reporting periods (Q4 2008 and later) to materially overstate its financial performance in those later reporting periods (Q4 2008 $1.8 million, Q1 2009 $0.453 million, Q2 2009 $87k, Q3 2009 $40k).

In effect, Overstock.com improperly created a cookie jar reserve to materially inflate future earnings or reduce future losses. Overstock.com ridiculously claimed that the collection of the entire amount of its underbillings (every single penny) “was not assured” and instead falsely claimed that a gain contingency existed rather than make a reasonable estimate of uncollectable amounts as required under SFAS No. 5. Therefore, Overstock.com improperly recognized income from underbilled fulfillment partners as amounts due to the company were collected on a non-GAAP cash basis, rather when they were earned under accrual accounting or GAAP. (Note: I recommend reading forensic accountant and author Tracy Coenen's blog for an explanation of how cookie jar reserves work.)

If Overstock.com would have properly followed GAAP and restated its previous financial reports as required, in Q4 2008 the company would have: (1) reported a net loss instead of a net profit, (2) reported sixteen consecutive losses instead of 15 consecutive losses, and (3) failed to meet mean analysts’ consensus expectations for earnings per share. Any one of the above three materiality yardsticks triggers a restatement of prior year's effected financial reports under SEC Staff Accounting Bulletin No. 99.

Overstock.com and SEC was alerted about GAAP violations

In February 2009, I alerted by the Securities and Exchange Commission and Overstock.com about the company’s improper use of a cookie jar reserve to inflate its financial performance in future reporting periods. While Overstock.com continues to stubbornly refuse to restate its financial report to comply with GAAP, both the SEC Enforcement Division and the Division of Corporation Finance have started parallel probes of the company.

Overstock.com’s failure to disclose the 2008 $785,000 overpayment to a fulfillment partner in financial reports and possible concealment from Grant Thornton

While Overstock.com disclosed underbilling its fulfillment partners in subsequent financial reports (2008 10-K report, 2008 10-K/A report, Q1 2009 10-Q report, and Q2 2009 10-Q report), the company made no disclosure about overpaying a fulfillment partner $785,000 in 2008, its recovery of that amount in Q1 2009, and its recognition of income when it was recovered in Q1 2009.

In its Q1 2009 10-Q, Overstock.com originally disclosed that:

In the first quarter of 2009, we reduced total cost of goods sold by $1.9 million for billing 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 the fourth quarter of 2008.

Note: Bold print and italics added by me.

Overstock.com's Q1 2009 10-Q report made no mention of the 2009 recovery of a 2008 overpayment to a fulfillment partner being included as income in that quarter. The company only mentioned "billing recoveries from partners who were underbilled in 2008" and "a refund due of overbillings by a freight carrier."

Questioning by SEC Division of Corporation Finance exposed hidden overpayment

It turns out that in its “unreviewed” Q3 2009 10-Q report, Overstock.com for the first time disclosed that the company overpaid a fulfillment partner in 2008 and recognized the recovery of such amount as income in Q1 2009. Overstock.com’s disclosure of the 2008 $785,000 overpayment to its fulfillment partner only came after SEC Division of Corporation Finance started asking very specific questions about the company’s financial disclosures. See below:

On October 1, 2009, the Company received a comment letter from the Division of Corporation Finance of the SEC regarding the Company’s 2008 Form 10-K/A and June 30, 2009 Form 10-Q. The Company responsed to the comment letter to the SEC on October 16, 2009 and October 21, 2009. The SEC reviewed the Company’s responses and on November 3, 2009 the SEC responded with a follow-up comment letter which requested additional information or clarification regarding, among other matters, a fulfillment partner overpayment (for which $785,000 was recognized as income in 2009 as it was received), fulfillment partner under billings (for which $580,000 was recognized as income in 2009 as it was received), overbillings by a freight carrier in 2008 (for which $301,000 was recognized in income in 2009 when the refunds were received) and an adjustment related to redeemable shares of the Company’s common stock (for which $705,000 was reclassified in 2009 from stockholder’s equity to redeemable common stock).

Note: Bold print and italics added by me.

In a follow-up Q3 2009 8-K report (paragraph 7) Overstock.com clarified that the $1.9 million it collected from underbilled fulfillment partners also included the recovery of an overpayment to a fulfillment partner in the amount of $785,000, contrary to its prior Q1 2009 10-Q disclosure:

In late Q1 2009, we received $785,000 relating to the partner overpayment discussed in point 1 above (even though the other issue with that partner remained unresolved). Thus, we recognized $785,000 in our 2009 Q1 Form 10-Q financials, which Grant Thornton reviewed as our auditors. In addition we highlighted $1.9 million (of which the $785,000 was a part) attributable to the collected overpayment, certain partner under-billing collections, and a freight carrier’s refund of overcharges in one-time, non-recurring income in that quarter’s earnings release, earnings conference call and Form 10-Q.

Note: Bold print and italics added by me.

Therefore, the Q1 2009 10-Q made no mention of any 2009 recovery of a 2008 overpayment to a fulfillment partner and the recognition of income in that quarter for that recovery. Overstock.com first disclosed the overpayment to a fulfillment partner only after the SEC Division of Corporation Finance questioned Overstock.com's financial disclosures.

Reasonable questions to ask are:

Why didn't Overstock.com disclose the overpayment to the fulfillment partner
earlier?

What was the company trying to hide?

The only reason why Overstock.com disclosed the overpayment is because the SEC Division of Corporation Finance made inquiries about the company's financial disclosures.

Grant Thornton alleges that they did not know about 2008 overpayment to fulfillment partner

Grant Thornton alleges that they did not know about the 2008 overpayment, 2009 subsequent recovery of such overpayment, and Overstock.com’s reporting of that recovery as income in Q1 2009 until October 2009, while they was assisting Overstock.com in responding to questions from the SEC Division of Corporation Finance. See below:

We disagree with the Company’s statement in paragraph 7 “that upon further consultation and review within the firm, Grant Thornton revised its earlier position” regarding the previously filed 2009 interim financial statements. This statement is not accurate. The Company brought the overpayment to a fulfillment partner to Grant Thornton’s attention in October. After additional discussions with the Company, the predecessor auditor and receipt of additional documentation from the Company we determined that the Company’s position as to the accounting treatment for the overpayment to a fulfillment partner was in error. Further the Company’s statement does not address the fact that the consultation noted in paragraph 5 was in relation to the ongoing incomplete review of the September 30, 2009 interim financial statements.

We have also read Item 4.02 of Form 8-K of Overstock.com, Inc. (“the Company”) dated November 16, 2009 and disagree with the statements concerning our Firm contained therein. During the course of our incomplete review of the Company’s September 30, 2009 financial statements, we advised the Company that disclosure should be made to prevent future reliance on its March 31, 2009 and June 30, 2009 financial statements. We advised the company to make the disclosure because we became aware that material modifications should be made to the previously filed 2009 interim financial statements to conform with US GAAP. Such modifications are necessary due to the Company having reduced its cost of goods sold in the first quarter of 2009 by receipt of a refund of an overpayment to a fulfillment partner. Further, the Company had additional items which we discussed that were still unresolved at the time we were dismissed, that could have a material impact on the first and second quarter financial statements for 2009. These items are identified by the Company in Paragraph 5 in item 4.01 of the Company’s Form 8-K.

Note: Bold print and italics added by me.

Therefore, Grant Thornton is implying that Overstock.com concealed the transaction from them or otherwise misled them during their review of the Q1 2009 10-Q and Q2 2009 10-Q. It sounds plausible, given Overstock.com’s failure to disclose the overpayment in its 2008 10-K report, 2008 10-K/A, Q1 2009 10-Q report, and Q2 2009 10-Q report.

Overstock.com claims that Grant Thornton had prior knowledge of the 2008 overpayment to the fulfillment partner and raised no objection to its accounting practices until October 2009

Patrick Byrne claimed that Grant Thornton had previously reviewed their accounting for the 2009 recovery of the 2008 overpayment and had no issue with reporting it as income in the company’s Q1 2009 10-Q reports:

On several occasions Grant Thornton discussed with and provided guidance on the accounting for the $785,000 fulfillment partner overpayment during and prior to October in the following respects:

a. Before Grant Thornton accepted our audit engagement in Q1 2009, it reviewed our filed 2008 Form 10-K and told us it was comfortable with our past accounting practices.

b. As our auditors, Grant Thornton reviewed our prior auditor’s 2008 Form 10-K audit work papers. Grant Thornton did not question or object to our accounting for the overpayment recovery at that time.

c. As our auditors, Grant Thornton reviewed our Q1 and Q2 2009 financial statements before we filed Form 10-Q’s for those quarters. At no time during those reviews did Grant Thornton question or object to our accounting for the overpayment recovery.

In addition Patrick Byrne claimed that later on in October 2009, Grant Thornton changed its position on the accounting for the Q1 2009 recognition of income from the recovery of a 2008 overpayment to a fulfillment partner:

d. On October 13, 2009, Grant Thornton reviewed the correspondence from our fulfillment partner and the events around the overpayment. Prior to our submission of our October 16 and 21 responses to an SEC comment letter that discussed the accounting for the overpayment recovery, Grant Thornton reviewed, edited and approved those responses, which included our accounting treatment for the overpayment recovery. Our local Grant Thornton engagement partner, Tom Eldredge, told us on October 14 that the local Grant Thornton engagement team had held conference calls within Grant Thornton to review our accounting treatment for the overpayment recovery, and that these conference calls extended to the regional and national offices. Mr. Eldredge told us that, after his review with the regional and national offices, “in light of the circumstances at the time and given the judgment utilized by Overstock, Grant Thornton had determined that our accounting treatment for this overpayment recovery was not unreasonable.”

However, Grant Thornton says that they never agreed with Overstock.com's improper accounting and wanted the company to restate its Q1 2009 10-Q and Q2 2009 10-Q reports because the overpayment was in 2008 and the recovery of that overpayment should not be reported as income in 2009. If Overstock.com concealed the transaction from Grant Thornton, its review of prior financial reports was based on the omission of material financial information by the company.

While Grant Thornton did not officially take a position that the 2008 financial reports must be restated, since its predecessor PricewaterhouseCoopers audited them, the restatement of the 2009 financial reports can only be accomplished by the restatement of the 2008 reports to correct the overpayment error.

Overstock.com’s stubborn failure to restate its financial reports to correct accounting errors as required by GAAP

The SEC has made its position clear in various successful legal actions that “GAAP do(es) not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of an error." Source: Cease and Desist order issued In the matter of Carl M. Apel, Administrative Proceeding in the Matter of Sun Communities Inc. and Sun Communities Operating Limited Partnership, and Cease and Desist Order Issued in the Matter of National Steel Corporation). However, Overstock.com is in fact deferring various “accounting adjustments arising from…the correction of an error” and violating GAAP.

In October 2009, Grant Thornton ultimately told Overstock.com that its Q1 2009 recognition of income from the recovery of a 2008 overpayment to a fulfillment partner violated GAAP and that the company must restate its prior financial reports to correct that error.

On November 13, Overstock.com fired Grant Thornton, rather than restate its financial reports as recommended by them and filed an “unreviewed” Q3 2009 10-Q report. However, CEO Patrick Byrne and CFO Steve Chesnut chickened out and did not certify those reports as required under Sarbanes-Oxley Sections 302 and 906. Afterwards, NASDAQ sent Overstock.com a letter warning the company of possible delisting of the company.

What really matters

What really matters is that during the course of assisting Overstock.com in answering questions from the SEC Division of Corporation Finance, Grant Thornton came upon additional information that appropriately led them to recommend the restatement of 2009 financial reports, which in turn meant the restatement of 2008 reports (See SAS 1 AU 560 and AU 561).

Even if Grant Thornton previously knew about the 2008 overpayment to a fulfillment partner and the reporting of the 2009 recovery of that overpayment as income in 2009, they are allowed to change their minds. Grant Thornton responsibly and appropriately recommended to Overstock.com that the company must restate its financial reports after obtaining new information during the course of the SEC Division of Corporation Finance probe of the company's financial disclosures. Grant Thornton valiantly did not give into pressure from its client Overstock.com and should be commended for not backing down from Byrne's bullying.

Patrick Byrne defended Overstock.com's 2008 financial reports with the following excuse:

Weighing all the facts and circumstances at the time, we decided it would be a mistake to book this overpayment as an asset as of December 31, 2008, deciding instead to recognize the sums as we recovered the money, that is, we thought the conservative position was the correct position.

However, according the SEC Staff Accounting Bulletin No. 99 on Materiality:

Registrants and auditors also should consider the effect of misstatements from prior periods on the current financial statements.

In this particular case, Grant Thornton appropriately concluded that accounting errors from 2008 were materially overstating Overstock.com's financial performance in 2009 by shifting income properly reported in 2008 to 2009.

Improper accounting for underbillings to fulfillment partners

The much larger issue getting lost in Overstock.com's bitter dispute with Grant Thornton is the company's improper accounting from underbilling its fulfillment partners before Q4 2008. Separate and apart from the overpayment issue, Overstock.com failed restate its financial reports to properly reflect when those underbillings were actually earned, less a reasonable estimate for uncollectable amounts.

As I detailed above, on October 24, 2008 Overstock.com announced that it discovered customer refund and credit errors and restated its financial reports from Q1 2003 to Q2 2008 to correct those errors. However, the October 2008 restatement did not include offsetting corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts. Overstock.com falsely claimed that a “gain contingency” existed by ridiculously claiming that the collection of the entire amount of that underbilling “was not assured” rather than make a reasonable estimate of uncollectable amounts as required by GAAP.

In its “unreviewed” Q3 2009 10-Q report Overstock.com later disclosed that it underbilled fulfillment partners $2.8 million in 2007 and $2.7 million in approximately the first nine months of 2008. Overstock.com originally announced the accounting error on October 24, 2008 and during that same quarter (Q4 2008 or from October 1 to December 31), the company quickly collected $1.8 million of $2.7 million underbilled amounts due from fulfillment partners that originated in 2008 or 66.67% of underbillings originating in 2008. In the next quarter, Q1 2009, Overstock.com collected another $453,000 of underbilled amounts due from fulfillment partners that originated in 2008 for a cumulative total of $2.253 million or 83.4% of underbillings originating in 2008.

To date, the company has collected $2.34 million of $2.7 million of underbilled amounts due from fulfillment partners that originated in 2008 about 87% of underbilled amounts due from fulfillment partners originating in 2008! The collection of significant amounts due from underbilling fulfillment partners in 2008 was assured and could have been reasonably estimated. The only question was how long it would take Overstock.com to collect such amounts.

See the updated score card below for the latest tally of Overstock.com's accounting errors based on computations from my second open letter to the SEC.

There is still an unexplained discrepancy of $438,000 in Overstock.com's Q1 2009 accounting errors that the company has failed to explain.

Overstock.com’s vilification of critics and unwillingness to restate financial reports shows deliberate intent to violate GAAP and SEC disclosure rules

The most important issue here is Overstock.com’s stubborn unwillingness to issue financial reports in compliance with GAAP and SEC disclosures rules, even ultimately after Grant Thornton told them to restate their financial reports. Rather than properly restate its financial reports to properly correct its accounting errors, Overstock.com wants to use those accounting errors in originating in prior years to materially overstate Q4 2008 and 2009's financial performance.

In addition, Overstock.com claims that it had no hint that the company underbilled fulfillment partners $5.5 million from Q1 2007 to Q3 2008, overpaid a fulfillment partner $785,000 during 2008, and was overbilled $301,000 from a freight carrier in Q4 2008. In other words, the company claims it had no clue that $6.285 million walked out the door in two years.

Yet during the entire period, CEO Patrick Byrne and former CFO David Chidester signed Sarbanes-Oxley certifications attesting to adequate internal controls and PricewaterhouseCoopers issued clean audit opinions. Why aren't heads rolling at the company, starting from the audit committee, the CEO, and the CFO?

Instead, Byrne showers PricewaterhouseCoopers, his audit committee, and his former and current CFO with praises despite their repeated failures to perform their respective responsibilities to insure GAAP compliant financial reports.

One has to wonder how high Overstock.com scored on PWC's internal audit risk assessment form, too. If Overstock.com scored low in audit risk, was PWC oblivious to its client's financial reporting risks, given that every single financial report issued by the company initially failed to comply with GAAP? If Overstock.com scored high in audit risk, why didn't PWC take adequate steps to insure that it would find material accounting errors during the course of its audits?

It is often said, that for criminals “the cover-up is more dangerous than the crime.” Here you have a clear case of scienter based on Overstock.com’s unwillingness to restate its financial reports and instead retaliate against its critics by vilifying them.

Grant Thornton's public slap down of Overstock.com

Apparently, Overstock.com CEO Patrick Byrne believes that he can scam Grant Thornton like I scammed Main Hurdman/Peat Marwick Main/KPMG back in my Crazy Eddie days. However, I never received a public flogging from Crazy Eddie's auditors, like Overstock.com received from its fired auditors. At least KPMG has tried to make others learn from their past mistakes and have graciously hosted two of my free speaking appearances for college students in the past.

Grant Thornton must be really pissed off and while I do not blame them for being upset by Byrne's ugly retaliation, they were warned by me.

Despite Patrick Byrne's vilification of me in order to stop me from exposing his malfeasance, I'll stick around because he is a gift that keeps on giving.

Respectfully,

Sam E. Antar

First additional note to the SEC:

Please research your censure case against PricewaterhouseCoopers regarding its audit client The Warnaco Group (NYSE: WRC). In that case, PWC helped Warnaco conceal the true nature of its restatements of financial reports. Overstock.com never disclosed the overpayment to a fulfillment partner in its 2008 10-K and 10-K/A reports that were audited by PWC. Byrne claims that PWC knew about the overpayment.

Second additional note to the SEC:

Please request that Overstock.com and PricewaterhouseCoopers explain in detail each and every individual change to revenue and expense items in the company's various restated or amended Consolidated Statements of Operations and individual changes to assets, liabilities, and retained earnings items in the company's various restated or amended Balance Sheets arising from its October 2008 restatement of financial reports due to its customer refund and credit errors.

I'll have more to say about the above two additional notes to the SEC in the near future.

What other bloggers are saying:

Gary Weiss Blog - Under Siege, Patrick Byrne Celebrates Black Friday at Little Big Horn

Today is the biggest retailing day of the year, Black Friday, and my favorite Internet retailer, Overstock.com's increasingly beleaguered, SEC-investigated, auditor-denouncing and, above all, incurably wacky CEO Patrick Byrne, is celebrating the day at Overstock's new headquarters: Little Big Horn.....

Byrne is trying to obscure the main issue, which is that independent auditors have a duty to do the right thing. That's, uh, why they're called "independent" auditors.

Floyd Norris (New York Times) - You Lie! No, You Lie!

Mr Byrne says Grant Thornton “told us it was comfortable with our past accounting practices” after going over the previous auditor’s work papers, and that when reviewing the first two quarterly reports it did not “question or object to our accounting for the overpayment recovery.”

That is not the same as saying the firm actually understood the details of the accounting.

Caleb Newquist (Going Concern) -Patrick Byrne: Noooo, Grant Thornton, You're Lying

Oh yeah, did we mention they’re still looking for an auditor? Shockingly, there are still no takers.

The final numbers from our poll show that KPMG is the winner of auditor most likely to be fired next by Overstock.com. We’re still waiting to hear who’s actually entertaining the idea of sabotaging their own firm with this little treat of a company. Stay tuned.

Tracy Coenen (Fraud Files) -Grant Thornton to SEC: Overstock.com is Lying

I would say it’s likely that this situation was used by Overstock to mask a number of accounting problems… with management throwing in everything and the kitchen sink, netting it all out, and using one fairly general explanation for all of it (rather than being forced to explain why one company’s accounting system can have so many errors)....

Now we’ve got a situation in which Overstock.com executives were concealing information from their auditors and lying about what their auditors knew and did not know. That escalates it to a whole new level. When management is lying and actively concealing, you can’t just dismiss the situation as “immaterial” because the dollar amounts are low.

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. If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

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. In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me and analyzing Overstock.com's financial reporting is a forensic accountant's wet dream.

I have never received any compensation from either Grant Thornton or KPMG.

Wednesday, November 25, 2009

Advice For Patrick Byrne: The Cover-up is Always More Dangerous Than the Crime For Lying CEOs Like You

Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne has engaged in a public dispute with Grant Thornton, the company's former auditors. Yesterday, Overstock.com issued a press release disputing claims by Grant Thornton that it did not approve the company recognizing the Q1 2009 recovery of a 2008 $785,000 overpayment to a fulfillment partner as income in 2009. Details are provided in my third Open Letter to the Securities and Exchange Commision.

Other blogs covering the latest events are:

Going Concern: "Patrick Byrne: Noooo, Grant Thornton, You’re Lying" by Caleb Newquist

Business Insider: "Overstock: Actually, Grant Thornton Is Lying (OSTK)" by Henry Blodget

New York Times:" You lie! No, You Lie!" by Floyd Norris

I will have a blog post out about those issues by Monday. However, I'll provide you with a small teaser.

Patrick Byrne apparently believes that he can scam Grant Thornton, like I scammed Main Hurdman/Peat Marwick Main/KPMG back in the Crazy Eddie days. A piece of advice for Patrick Byrne: The cover-up is always more dangerous than the crime for lying CEOs like you.

Happy Thanksgiving holiday to all!

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 members of his family mastermind one of the largest securities frauds uncovered during the 1980's. If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

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.

In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me and analyzing Overstock.com's financial reporting is a forensic accountant's wet dream.

Monday, November 23, 2009

Open Letter to the Securities and Exchange Commission Part 3: Overstock.com Lied About Grant Thornton and Concealed Error

Updated:

To the Securities and Exchange Commission:

In my last letter, I detailed how Overstock.com (NASDAQ: OSTK) deliberately concealed a 2008 overpayment to a fulfillment partner that was later recovered and improperly reported as income in Q1 2009. Now Grant Thornton has written a rare public letter to Overstock.com agreeing with me and taking issue with its former client's representations regarding that certain fulfillment partner in last week's conference call, and filings with the SEC. See below:

In its Q1 2009 10-Q, Overstock.com originally disclosed that:

In the first quarter of 2009, we reduced total cost of goods sold by $1.9 million for billing 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 the fourth quarter of 2008.

Note: Bold print and italics added by me.

Overstock.com's Q1 2009 10-Q report made no mention of the 2009 recovery of a 2008 overpayment to a fulfillment partner. However, in its recent 8-K report for Q3 2009, Overstock.com later claimed that the $1.9 million collected from underbilled fulfillment partners also included the recovery of an overpayment to a fulfillment partner in the amount of $785,000, contrary to its prior disclosure:

In late Q1 2009, we received $785,000 relating to the partner overpayment discussed in point 1 above (even though the other issue with that partner remained unresolved). Thus, we recognized $785,000 in our 2009 Q1 Form 10-Q financials, which Grant Thornton reviewed as our auditors. In addition we highlighted $1.9 million (of which the $785,000 was a part) attributable to the collected overpayment, certain partner under-billing collections, and a freight carrier’s refund of overcharges in one-time, non-recurring income in that quarter’s earnings release, earnings conference call and Form 10-Q.

Note: Bold print and italics added by me.

In that same Q3 2009 8-K report (paragraph 7), Overstock.com claimed that Grant Thornton approved of the company's recognizing that 2009 $785,000 recovery of the 2008 overpayment to its fulfillment partner as income in Q1 2009, rather than restate its 2008 and 2009 financial reports, as I recommended in my blog:

As our auditors, Grant Thornton reviewed our financial statements in Q1 and Q2 2009 before we filed Form 10-Q’s for those quarters. Throughout 2009, our Audit Committee has repeatedly asked Grant Thornton if there was any accounting that it would do differently, and repeatedly received the answer, “No.” In fact, as recently as late-October 2009, Grant Thornton confirmed to us that it supported our accounting method for recognizing the $785,000.

Note: Bold print and italics added by me.

According to Grant Thornton's letter, it did not learn about the overpayment or recovery until October 2009 and they wanted Overstock.com to restate its 2009 financial reports, as I recommended. While Grant Thornton did not officially take a position that the 2008 financial reports must be restated, since its predecessor PricewaterhouseCoopers audited them, the restatement of the 2009 financial reports can only be accomplished by the restatement of the 2008 reports to correct the accounting error. Grant Thornton stated in its letter:

We disagree with the Company’s statement in paragraph 7 “that upon further consultation and review within the firm, Grant Thornton revised its earlier position” regarding the previously filed 2009 interim financial statements. This statement is not accurate. The Company brought the overpayment to a fulfillment partner to Grant Thornton’s attention in October. After additional discussions with the Company, the predecessor auditor and receipt of additional documentation from the Company we determined that the Company’s position as to the accounting treatment for the overpayment to a fulfillment partner was in error. Further the Company’s statement does not address the fact that the consultation noted in paragraph 5 was in relation to the ongoing incomplete review of the September 30, 2009 interim financial statements.

We have also read Item 4.02 of Form 8-K of Overstock.com, Inc. (“the Company”) dated November 16, 2009 and disagree with the statements concerning our Firm contained therein. During the course of our incomplete review of the Company’s September 30, 2009 financial statements, we advised the Company that disclosure should be made to prevent future reliance on its March 31, 2009 and June 30, 2009 financial statements. We advised the company to make the disclosure because we became aware that material modifications should be made to the previously filed 2009 interim financial statements to conform with US GAAP. Such modifications are necessary due to the Company having reduced its cost of goods sold in the first quarter of 2009 by receipt of a refund of an overpayment to a fulfillment partner. Further, the Company had additional items which we discussed that were still unresolved at the time we were dismissed, that could have a material impact on the first and second quarter financial statements for 2009. These items are identified by the Company in Paragraph 5 in item 4.01 of the Company’s Form 8-K.

Note: Bold print and italics added by me.

In other words, Grant Thornton says that they not know about the 2008 overpayment to a fulfillment partner or the Q1 2009 recovery of the overpayment until October 2009 or five months after Overstock.com filed its Q1 2009 10-Q report with the SEC. Overstock.com filed its Q1 2009 10-Q report on May 1, 2009 and Grant Thornton did not learn about the 2008 overpayment to the fulfillment partner or the 2009 recovery of that overpayment until October 2009 when it was reviewing the company's Q3 2009 financial reports.

The 2008 overpayment to the fulfillment partner and the 2009 recovery of that overpayment was never disclosed in Overstock.com's Q1 2009 10-Q report. It was hidden within recoveries from other fulfillment partners that were underbilled by the company from Q1 to Q3 2008, as I detailed above and in my last letter. Those other recoveries from fulfillment partners who were underbilled in 2008 were improperly reported as income in 2009 and the company must restate its 2008 financial reports to correct those errors, too.

In its 8-K filing above and during a recent conference call, Overstock.com had claimed that Grant Thornton agreed with the company that the recovery of the overpayment to the fulfillment partner was properly reported as income in 2009, even though that the company overpaid the fulfillment partner in 2008. However, Grant Thornton says that they never agreed with Overstock.com's improper accounting. Grant Thornton wanted Overstock.com to restate its prior financial reports to correct that error and other errors as I have detailed in my two previous letters (see below for links to those letters).

Overstock.com later fired Grant Thornton after they told the company to restate its financial reports as I called for. Subsequently, the company filed an "unreviewed" Q3 2009 10-Q report, and omitted required Sarbanes-Oxley certifications from its CEO Patrick Byrne and its CFO Steve Chesnut. On Friday, Overstock.com disclosed that NASDAQ sent the company a letter warning of a possible de-listing:

...notifying the company that it violated NASDAQ Listing Rules when it filed its Quarterly Report on Form 10-Q for the period ended September 30, 2009 because the filing wasn’t reviewed in accordance with Statement of Auditing Standards No. 100. The letter also notified the company that the filing did not contain the certifications required under sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Apparently, CEO Patrick Byrne duped New York Times columnist Floyd Norris, saying:

Grant Thornton, on the other hand, reviewed all this when they took the case, reviewed it at the end of Q1, reviewed it at the end of Q2, and in all cases they were asked, “Would you do this any other way?” and they said, “No.”

As I detailed above, Overstock.com concealed its overpayment to its fulfillment partner in its Q1 2009 10-Q (filed on May 1, 2009) and Grant Thornton did not learn about the overpayment until October. There is another $438,000 discrepancy that I outlined is my last letter, which may be one of the "unresolved" items that Grant Thornton referred to in its letter.

Overstock.com's false disclosures about the actions of its auditors and continued stonewalling of the restatement of its financial reports to comply with Generally Accepted Accounting Principles (GAAP) is a clear 10b-5 violation and also a violation of NASDAQ listing rules.

In any case, I warned Grant Thornton about their new audit client in March 2009. Finally, they know why!

Respectfully,

Sam E. Antar

Annexed hereto:

08/05/09: Open Letter to the Securities and Exchange Commission: Stop Overstock.com GAAP Violations Now!

11/22/09: Open Letter to the Securities and Exchange Commission Part 2: New Information on Overstock.com's GAAP and SEC Disclosure Violations

Blog update:

Floyd Norris covers the latest events here , Gary Weiss covers it here, and Caleb Newquist here.

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. If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

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.

In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me and analyzing Overstock.com's financial reporting is a forensic accountant's wet dream.

Sunday, November 22, 2009

Open Letter to the Securities and Exchange Commission Part 2: New Information on Overstock.com's GAAP and SEC Disclosure Violations

To the Securities and Exchange Commission:

On November 18, 2009, Overstock.com (NASDAQ: OSTK) held conference call where CEO Patrick M. Byrne, company President Jonathan E. Johnson, and CFO Steve Chesnut sought to justify the company's improper treatment of accounting errors under investigation by the SEC, the company's firing of Grant Thornton as its auditors after they told the company to correct its financial reports, and the company's filing of an "unreviewed" Q3 2009 10-Q with the SEC. Patrick Byrne did not permit me to ask crucial questions about Overstock.com's accounting irregularities while I was on the call and Jonathan Johnson lied when he said, "We we don't have any other questions lined up."

Therefore, in this letter I will analyze certain accounting issues under investigation by the SEC based on new company disclosures. In addition, I will show why Overstock.com's excuse for its treatment of accounting errors, which is based on the false premise that a "gain contingency" existed, lacks any credibility. Out of necessity I need to reiterate certain points I made in previous blog posts in order to explain new points below.

Overstock.com created an improper "cookie jar" reserve

In my first open letter to the SEC, I have described how in October 2008 Overstock.com restated its financial reports from Q1 2003 to Q3 2008 due to customer refund and credit errors. However, Overstock.com's restatement of financial reports failed to include corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts. In effect, Overstock.com created what is known as a “cookie jar” reserve to materially overstate its future financial performance in violation of Generally Accepted Accounting Principles (GAAP) and SEC disclosure rules.

I recommended that Overstock.com correct its GAAP violations by restating its financial reports. Since then, both the Enforcement Division and Division of Corporation Finance started investigating Overstock.com's financial disclosures based on the analysis that I provided them.

Grant Thornton was fired after agreeing with my analysis of Overstock.com's improper accounting

As early as February 2009, I started notifying (here and here) both Overstock.com and the SEC of the company's most recent GAAP violations. Rather than appropriately restate Overstock.com's financial reports, Patrick Byrne responded on an internet chat board in an unsigned post using an alias saying that:

Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about..... It's just a guy on a street corner, spouting gibberish, hoping someone will toss him a quarter.

After I complained to Overstock.com's audit committee member Joseph J. Tabacco and the SEC, Byrne removed his unsigned chat board post using an alias and replaced it with signed post identifying himself as "Patrick M. Byrne."

On November 13, 2009, Overstock.com’s audit committee and board of directors fired Grant Thornton as the company’s auditors, just about eight months after they replaced previously fired PricewaterhouseCoopers (PWC) as auditors. Grant Thornton was assisting the company in dealing with both SEC probes.

Apparently, Grant Thornton did not believe Patrick Byrne's claim that my analysis of Overstock.com's improper accounting was "gibberish." Grant Thornton ultimately agreed with me that Overstock.com's financial reports must be restated due to the same material accounting errors I pointed out in my blog.

However, Overstock.com claims that PWC disagrees with Grant Thornton:

Thus, we are in a quandary: one auditing firm [Grant Thornton] won’t sign-off on our Q3 Form 10-Q unless we restate our 2008 Form 10-K, while our previous auditing firm [PricewaterhouseCoopers] believes that it is not proper to restate our 2008 Form 10-K. Unfortunately, Grant Thornton’s decision-making could not have been more ill-timed as we ran into SEC filing deadlines.

Note: Bold print and italics added by me. Bracketed information added by me for clarity.

Simply said, PWC's audit opinions on Overstock.com's financial reporting are worthless. As I will describe later, the simple fact is that since Overstock.com's inception, every single financial report for each and every reporting period at least initially violated GAAP or some other SEC disclosure rules. Likewise, every audit opinion issued by PricewaterhouseCoopers during those corresponding periods up to its last one in 2008 was flawed, too.

Investors cannot accurately compare changes in Overstock.com's financial performance from any reporting period to any previous comparable reporting period due to the company's GAAP violations. Those distortions in financial performance caused by material accounting errors in 2008 that overstated the Overstock.com's 2009 financial performance caused investors to overvalue the company's shares.

Yet during the "unreviewed" Q3 2009 10-Q conference call, Patrick Byrne praised PricewaterhouseCoopers saying:

Price gave us great service. We didn't have any beef with Price.

In fact, Grant Thornton agreed with me that PWC's last audit in 2008 was flawed and wanted Overstock.com to "restate" its "2008 Form 10-K" due to material accounting errors, even though Patrick Byrne has claimed that such errors were not material. Afterwards, Overstock.com fired Grant Thornton as its auditors, rather than restate the company's financial reports as they recommended.

During the "unreviewed" Q3 2009 10-Q conference call, an embittered Patrick Byrne expressed his utter contempt for Grant Thornton saying:

I am dissing [is people on the scene] -- I mean, I think Grant Thornton -- we're not going to be exchanging Christmas cards.

Later on, Jonathan Johnson chimed in saying:

...I'd just say that Pricewaterhouse has been very supportive of the positions that we've taken with the SEC.

In other words, Overstock.com and PricewaterhouseCoopers are "joined at the hip" and standing together "head to head and toe to toe" in their arrogant battle against the SEC, Grant Thornton, and the interests of investors to avoid restating its financial reports to comply with GAAP and SEC disclosure rules. In their collective twisted minds they just want to continue issuing financial reports that violate GAAP and SEC disclosure rules as they have done consistently in the past -- everyone else be damned!

Failure to maintain adequate internal controls

Overstock.com has utterly failed to maintain adequate internal controls and violated Section 13 of the Securities Act of 1934. In each and every period, CEO Patrick Byrne, former CFO David Chidester, and current CFO Steve Chesnut signed various certifications required under sections 302 and 906 of the Sarbanes-Oxley Act that turned out to be false.

NASDAQ de-listing letter

On November 20, 2009, Overstock.com disclosed the receipt of a de-listing letter from NASDAQ:

...notifying the company that it violated NASDAQ Listing Rules when it filed its Quarterly Report on Form 10-Q for the period ended September 30, 2009 because the filing wasn’t reviewed in accordance with Statement of Auditing Standards No. 100. The letter also notified the company that the filing did not contain the certifications required under sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Note: Bold print and italics added by me.

In the past, Patrick Byrne, David Chidester, and Steve Chesnut had no issues signing "certifications required under sections 302 and 906 of the Sarbanes-Oxley Act of 2002" that in each and every case initially turned out to be false. Evidently, both Patrick Byrne and new CFO Steve Chesnut are getting cold feet as they are certainly afraid to certify Overstock.com's latest reports as required by the Sarbanes-Oxley Act.

Let's review Overstock.com's history GAAP and SEC disclosure violations before I analyze recent disclosures by the company and show why its treatment of accounting errors based on the false premise that a "gain contingency" existed lacks any credibility.

Background: A brief history of Overstock.com's GAAP and SEC disclosure violations and PWC's failed audits

In January 2006, Overstock.com restated financial reports issued from Q1 2002 to Q3 2005 due to inventory accounting errors.

In February 2008, the SEC Division of Corporation Financial concluded that Overstock.com violated GAAP in reporting revenues from the company's inception or from day one. 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.

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.

From Q2 2007 to Q2 2008, Overstock.com reported an improper EBITDA (earnings before interest, taxes, depreciation, and amortization) that violated SEC Regulation G. Overstock.com improperly computed EBITDA by starting its calculation with operating income and adding back interest, taxes, depreciation, amortization, and stock based compensation. In other words, Overstock.com improperly defined EBITDA as operating income before interest, taxes, depreciation, amortization, and stock based compensation.

However, SEC Regulation G requires EBITDA to be computed as net income (not operating income) before interest, taxes, depreciation, and amortization (and not stock-based compensation). Therefore, Overstock.com was not permitted by Regulation G to use operating income as the starting point to compute EBITDA and the company was not allowed to eliminate stock-based compensation from its EBITDA calculation.

Since Overstock.com had reported losses from discontinued operations in various reporting periods, by improperly using operating income as the starting point to calculate EBITDA, it was materially overstating EBITDA by the amount of loss from discontinued operations. Likewise, by Overstock.com improperly eliminating stock-based compensation from its EBITDA calculation, the company was materially overstating its reported EBITDA by such amount in each reporting period.

When I confronted management about its EBITDA violations, they violated SEC rule 10b-5 by lying about their compliance with SEC Regulation G during Q2 and Q3 2008 conference calls. Just a few weeks later, Overstock.com finally corrected its improper EBITDA calculation by calling it "adjusted EBITDA" when it restated financial reports as described below and amended its filings with the SEC to correct certain newly disclosed GAAP violations.

Recently, the SEC took its first enforcement action under Regulation G and obtained an injunction and civil penalties against SafeNet Inc and its various officers for similar violations of Regulation G. I recommend that SEC also look into false representations of compliance under Regulation G by Overstock.com management when confronted by me about such violations.

Overstock.com's restatement of financial reports due to customer refund and credit errors improperly excluded offsetting costs and reimbursements due from its fulfillment partners

In October 2008, Overstock.com restated its financial reports from Q1 2003 to Q2 2008 due to customer refund and credit errors. It was the second time in two years that Overstock.com restated its financial reports due to GAAP violations. In fact, financial reports from Q1 2003 to Q3 2005 were restated twice: in 2006 due to inventory accounting errors and in 2008 due to customer refund and credit errors. PricewaterhouseCoopers had audited Overstock.com's prior financial reports and gave clean audit opinions prior to each restatement. Those clean audit opinions turned out to be false.

In the October 2008 restatement of financial reports, 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. In addition, Overstock.com corrected its non-compliant EBITDA measure (as described above) in those amended financial reports. However, in the explanatory notes to those amended financial reports filed with the SEC, Overstock.com only made reference to corrections of its revenue accounting errors and customer refund and credit errors, but made no reference to the correction its non-compliant EBITDA calculation to comply with SEC Regulation G.

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 of accumulated losses in prior reporting periods.

Overstock.com created a "cookie jar" reserve to materially overstate future financial performance

However, the October 2008 restatement did not include corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts. In other words, Overstock.com should have gone back and corrected or restated its financial reports to reflect income already earned from offsetting costs and reimbursements due from its fulfillment partners, less a reasonable estimate for uncollectable amounts. (See SFAS No. 154 and SFAS No 5 paragraph 1, 2, 8 and 23). It didn’t.

Instead, Overstock.com improperly deferred income than it earned but underbilled its fulfillment partners during prior reporting periods (before Q3 2008) to by moving income to future reporting periods (Q4 2008, Q1 2009, Q2 2009, and Q3 2009). In effect, Overstock.com improperly created a cookie jar reserve to materially inflate future earnings or reduce future losses. Overstock.com falsely claimed that a “gain contingency” existed and improperly recognized income from its fulfillment partners as monies were collected in future reporting periods on a non-GAAP cash basis (Q4 2008 $1.8 million, Q1 2009 $0.453 million, Q2 2009 $87k, Q3 2009 $40k).

If Overstock.com would have properly followed GAAP and restated its previous financial reports as required, in Q4 2008 the company would have: (1) reported a net loss instead of a net profit, (2) reported sixteen consecutive losses instead of 15 consecutive losses, and (3) failed to meet mean analysts’ consensus expectations for earnings per share. Any one of the above three materiality yardsticks triggers a restatement of prior year's effected financial reports under SEC Staff Accounting Bulletin No. 99.

How GAAP violations arising in 2008 materially overstated Overstock.com's financial performance in Q1 2009

PricewaterhouseCoopers improperly certified Overstock.com's 2008 financial reports and issued a clean audit opinion. As I described above, Grant Thornton agrees with me that the company's 2008 financial reports must be restated due to the GAAP violations I detailed above. Those GAAP violations materially overstated Overstock.com's financial performance in 2009 financial reports that Grant Thornton was supposed to audit before they were fired by the company. As I will describe below, accounting errors arising in 2008 inflated Overstock.com's financial performance in Q1 2009 as follows:

  • $453,000 collected from fulfillment partners underbilled in 2008

  • $785,000 recovered from a fulfillment partner who overbilled the company in 2008

  • $224,000 refund from a freight carrier who overbilled the company in 2008

  • $438,000 of explained discrepancies in disclosures.

In Q1 2009, Overstock.com reported a net loss of $2.099 million. However, the company should have reported a much bigger net loss of $4 million had it properly followed GAAP and materially understated its net loss by $1.9 million.

Overstock.com's latest disclosures show that the company hid a previously undisclosed accounting error and show even more accounting errors

In its Q1 2009 10-Q, Overstock.com disclosed that:

In the first quarter of 2009, we reduced total cost of goods sold by $1.9 million for billing 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 the fourth quarter of 2008.

Note: Bold print and italics added by me.

In my previous open letter, I estimated collections from fulfillment partners in Q1 2009 at $1.411 million due to Patrick Byrne's deliberately vague Q1 2009 conference call remarks that the company received a refund from a freight carrier who overbilled the company "several hundred thousand dollars" in Q4 2008.

In my original analysis, I estimated that the refund received from that freight carrier was $500,000 based on Byrne's vague remarks. Therefore, I originally estimated the components of Overstock.com's Q1 2009 accounting errors as follows: $1.4 million collections from fulfillment partners underbilled in 2008 and $500,000 refunds from a freight carrier who overbilled the company in Q4 2008.

Based on Overstock.com's "unreviewed" Q3 2009 10-Q, I now estimate that the freight carrier refunded the company $224,000 in Q1 2009 and not $500,000. Overstock.com disclosed:

Also for the nine months period ended September 30, 2009, we reduced total cost of goods sold by $301,000 due to a refund of overbillings by a freight carrier for charges from the fourth quarter of 2008.

In addition, Overstock.com disclosed:

For the three months ended September 30, 2009, we reduced total cost of goods sold by $77,000 due to a refund of overbillings by a freight carrier for charges from the fourth quarter of 2008.

Since the company did not disclose receiving any refunds from a freight carrier in Q2 2009, I computed the amount of the refund from the freight carrier in Q1 2009 as follows: 9 months ended September 30 total of $301,000, less 3 months ended September 30 total of $77,000, equals Q1 2009 total of $224,000.

It turns out that in Q1 2009 Overstock.com had a previously undisclosed accounting error hidden in its financial disclosures. As I detailed above, Overstock.com originally claimed that it recovered:

...$1.9 million for billing recoveries from partners who were underbilled in 2008... and a refund due of overbillings by a freight carrier for charges from the fourth quarter of 2008.

However, in a recent 8-K report for Q3 2009, Overstock.com later claimed that the $1.9 million collected from underbilled fulfillment partners also included the recovery of an overpayment to a fulfillment partner in the amount of $785,000 contrary to its prior disclosure. See below:

In late Q1 2009, we received $785,000 relating to the partner overpayment discussed in point 1 above (even though the other issue with that partner remained unresolved). Thus, we recognized $785,000 in our 2009 Q1 Form 10-Q financials, which Grant Thornton reviewed as our auditors. In addition we highlighted $1.9 million (of which the $785,000 was a part) attributable to the collected overpayment, certain partner under-billing collections, and a freight carrier’s refund of overcharges in one-time, non-recurring income in that quarter’s earnings release, earnings conference call and Form 10-Q.

Note: Bold print and italics added by me.

Overstock.com may have hidden another accounting error in its financial disclosures. As I detailed above, originally Overstock.com claimed that:

...$1.9 million for billing recoveries from partners who were underbilled in 2008... and a refund due of overbillings by a freight carrier for charges from the fourth quarter of 2008.

Later the company disclosed that the $1.9 million amount included:

...$785,000 relating to the partner overpayment....

In Q1 2009, Overstock.com collected $453,000 from fulfillment partners it underbilled in 2008 and the company received a $224,000 refund from a freight carrier. Therefore, we are left with a $438,000 unexplained discrepancy.

See the updated chart below for the impact of Overstock.com's 2008 GAAP violations on 2009's financial reports based on the company's disclosures to date:


The distortions in Overtsock.com financial performance caused by its failure to restate its financial reports to correct accounting errors is actually greater than quarterly effects on reported income as detailed in the chart above. Overstock.com understated income in periods before Q4 2008 and likewise overstated income starting in Q4 2008. Therefore, any income earned in a prior reporting period shifted to a future comparable period doubles the increase in financial performance.

For example, if a company underreports income by $2 million in Q1 2008 and moves that income into Q1 2009, you have an overstatement of Q1 2009 income by $2 million. However, the increase in financial performance is $4 million due to improper shifting of income. It is known in forensic accounting as the "double up effect" that results from a company using a "cookie jar" reserve to manipulate future earnings.

Overstock.com's phony "gain contingency"

As I discussed above, Overstock.com falsely claimed that the future recoveries of amounts underbilled to fulfillment partners was a “gain contingency” because the recovery of such underbilled amounts "was not assured" (Sources: 2008 10-K, Q1 2009 10-Q, and Q2 2009 10-Q). 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, Overstock.com improperly failed to disclose any potential “gain contingency” in its prior Q3 2008 10-Q report, when it originally disclosed its accounting errors (See: SFAS No. 5 Paragraph 17b).

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. There was no question that Overstock.com was owed money from its fulfillment partners. As I will describe below, the recovery of substantial amounts due Overstock.com from underbilled fulfillment partners was assured, contrary to company claims that the collection of all such amounts was "not assured." Therefore, no gain contingency existed under accounting rules.

Overstock.com's ridiculous claim that the entire amount of underbillings to fulfillment partners was "not assured"

The company improperly claimed that the collection entire amount of underbillings to fulfillment partners was “not assured" rather than make a reasonable estimate of uncollectable amounts as required by SFAS No 5 paragraph 1, 2, 8 and 23. In other words, Overstock.com made the ridiculous claim that every single penny that it underbilled fulfillment partners in the past was uncollectible, even though it knew that significant amounts due from fulfillment partners (especially underbillings originating in 2008) were collectable. In fact, Overstock.com collected a significant amount of underbilled "fees and charges" from fulfillment partners in that same period (October 1 to December 31) that it announced its error (on October 24).

Following the money trail

When Overstock.com sells fulfillment partner inventory, customers promptly remit cash to the company. Afterwards, Overstock.com remits the portion cash proceeds due to its fulfillment partners for the inventory it sold to its customers.

According to Overstock.com’s “Supplier Agreement” with fulfillment vendors, the company (Source: Overstock.com correspondence to SEC Division of Corporation Finance):

Remit(s) semi-monthly payments within 2 business days of the 1st and 16th of each month for Product sold, subject to offsets. Payments shall be made net 30.

Note: Bold print and italics added by me.

Overstock.com floats the cash that it receives from customers and is later required to pay fulfillment partners in up to 30 days. In addition, Overstock.com retains the right to offset various errors against future remittances to its fulfillment partners. Therefore, if the fulfillment partners are still doing business with Overstock.com, all that the company had to do is to withhold a larger portion of the monthly remittances from such fulfillment partners (up to a few months, if necessary) to recover underbilling errors.

The greatest amount of the underbillings would certainly be attributable to its higher volume fulfillment partners who sold the most merchandise. Those high volume fulfillment partners are likely to be long time and current company suppliers of merchandise. Therefore, the 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 fulfillment partners was far more certain than recouping money in credit card disputes from its average customers.

Overstock.com collected significant amounts due from underbilled fulfillment partners in a very short period of time

In its "unreviewed" Q3 2009 10-Q, Overstock.com claimed that:

During 2008, we discovered that we had underbilled our fulfillment partners for certain fees and charges related to returns during 2007, and the nine months ended September 30, 2008, due to a systems issue. Of the total $5.5 million underbilling, $2.8 million related to 2007 and $2.7 million related to the nine months ended September 30, 2008. We contacted the affected fulfillment partners and in our negotiations with them over several months, we agreed to forgive the $2.8 million related to 2007 and to seek to recover the $2.7 million related to 2008 over time from our future sales of the fulfillment partners’ products during the remainder of 2008 and 2009. As a result of the negotiations we later agreed to forgive an additional $375,000. We have recovered a total of $2.3 million through September 30, 2009, including $1.8 million during the three months ended December 31, 2008 and $580,000 during the nine months ended September 30, 2009.

Note: Bold print and italics added by me.

Overstock.com announced its customer refund and credit error on October 24, 2008. During that same quarter (Q4 2008 or from October 1 to December 31), Overstock.com collected $1.8 million of $2.7 million underbilled amounts due from fulfillment partners that originated in 2008 or 66.67% of underbillings originating in 2008.

In the next quarter Q1 2009, Overstock.com collected another $453,000 of underbilled amounts due from fulfillment partners that originated in 2008 for a cumulative total of $2.253 million or 83.4% of underbillings originating in 2008.

To date, the company collected $2.34 million of $2.7 million of underbilled amounts due from fulfillment partners that originated in 2008 about 87% of underbilled amounts due from fulfillment partners originating in 2008! The collection of significant amounts due from underbilling fulfillment partners in 2008 was assured. The only question was how long it would take Overstock.com to collect such amounts.

During the Q3 2009 10-Q conference call, Patrick Byrne admitted:

...we collected ultimately $2.4 million. $1.8 million, we were actually able to collect in the fourth quarter. So -- and we learned about this and collected it quickly. Of the -- there's a remaining $600,000 that has dribbled in over this year and we recognize that as it came in.

Note: Bold print and italics added by me.

Therefore, Overstock.com's management had to know that the collection of significant amounts due from underbilling of its fulfillment partners in 2008 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 miserably failed to make a reasonable estimate of amounts collectable from its fulfillment partners. The company ridiculously claimed that the collection the entire amount of underbillings due from its fulfillment partners originating in 2008 "was not assured" in justifying its false claimed gain contingency regarding amounts owed it.

Other unanswered questions

Another unanswered question is how could Overstock.com, without any hint as it claims, entirely miss such a large magnitude of underbillings to fulfillment partners ($2.8 million in 2007 and $2.7 million from Q1 to Q3 2008) and the overpayments to a fulfillment partner ($785,000 in the same period) with a combined total of $6.285 million in just 21 months? Add to that total another $301,000 of overbilling from a freight carrier in Q4 2008 and you have $6.586 million in money going out the door within a 24 month period without anyone claiming to notice it. Yet during the entire period, CEO Patrick Byrne and former CFO David Chidester signed Sarbanes-Oxley certifications attesting to adequate internal controls and PricewaterhouseCoopers issued clean audit opinions. Why aren't heads rolling at the company, starting from the audit committee, the CEO, and the CFO?

In April 2008, Jonathan Johnson sold almost $1 million in stock (Details here). The next month, then CFO David Chidester cashed out about $77,000 from selling his Overstock.com shares. As I detailed above, in October 2008 Overstock.com announced its customer refund and credit errors and restated its financial reports without taking into account offsetting costs and reimbursements due from its fulfillment partners.

In January 2009, former CFO David Chidester was merely demoted to Senior Vice President, Internal Reporting and Information. In other words, he is still intimately involved in the company's financial reporting process. In March 2009, James V. Joyce departed from the Board of Directors and received a mysterious $1.25 million "bonus" exit payment for terminating his consulting agreement with the company or about 3.5 times his annual compensation under that agreement.

I have some answers and I hope to explore those unanswered questions more thoroughly with the SEC in the near future.

Patrick Byrne ducked crucial questions during the "unreviewed" Q3 2009 10-Q conference call

I was not permitted to ask any questions while I attended Overstock.com's "unreviewed" Q3 2009 10-Q conference call. Patrick Byrne and his other nitwits Jonathan Johnson and Steve Chesnut were trying to stonewall any serious discussion of the specific issues I detailed above.

Jonathan Johnson, knowing that I was on the call and wanted to ask questions, lied and said:

Well we don't have any other questions lined up.

He cut short the conference call and the management team ran for the exits.

GAAP requires restatement of Overstock.com's financial reports to correct all errors

Under Statement of Financial Accounting Standards No. 154, Overstock.com is required to restate each affected prior period financial report to reflect when the underbilled cost reimbursements and fees due from fulfillment partners 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 uncollectable underbilled amounts.

In any case it is the SEC's position that "GAAP does not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of an error." Source: Cease and Desist order issued In the matter of Carl M. Apel, and Administrative Proceeding in the Matter of Sun Communities Inc. and Sun Communities Operating Limited Partnership, Cease and Desist Order Issued in the Matter of National Steel Corporation). Therefore, no matter what excuse Overstock.com comes up with, its financial reports must be restated to correct all of its accounting errors and Grant Thornton concurred that a restatement was required too, before they were fired.

Other issues

Patrick Byrne has raised the issue of my involvement with Barry Minkow and Usana (NYSE: USNA) while acknowledging that I am "an expert in the business of exposing frauds." Allow me to reiterate that I have not been compensated by any party, that I was never compensated by any party, and that no party has ever promised to compensate me for analyzing Overstock.com's accounting and financial disclosures. I do not own any position in Overstock.com securities, I never had any position in Overstock.com securities, and I will never take any position in Overstock.com securities. My analysis of Overstock.com, the actions of its directors, management and auditors, and its financial reporting is a free voluntary public service to the SEC.

My interest in Overstock.com has not waned and will not wane despite Patrick Byrne's personal attacks on myself and my character and efforts by his paid crony Judd Bagley to interfere in my divorce which are specifically designed to discourage me from analyzing the company's financial disclosures and from engaging in communications such as this one with you.

If anything, Patrick Byrne's deliberate efforts to attack my credibility and character, rather than promptly correct Overstock.com's financial reporting violations after they were alerted by me in February 2009 provides clear evidence of scienter under the Private Securities Litigation Reform Act (PSLRA).

Respectfully,

Sam E. Antar

Note:

Please read my guest article in Newsweek entitled, "Bernie Madoff's Giant Ponzi Scheme" and Crain's New York Business article entitled "Crazy Like a Fox" by Aaron Elstein.

Other bloggers closely following financial reporting violations by Overstock.com are:

Forensic accountant and author Tracy Coenen,

Investigative journalist and author Gary Weiss, and

Blogger William K. Wolfrum (here and here).

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. If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

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.

In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me and analyzing Overstock.com's financial reporting is a forensic accountant's wet dream.

Wednesday, November 18, 2009

Overstock.com CEO Patrick Byrne Ducks Crucial Questions About GAAP Violations During Call

This evening Overstock.com (NASDAQ: OSTK) held a conference call to discuss certain financial reporting violations covered extensively in this blog, their firing of Grant Thornton as their auditors who agreed with me on the accounting issues now being investigated by the SEC, and their unprecedented filing on an "unreviewed" Q3 2009 10-Q.

I sent emails to Overstock.com CEO Patrick Byrne (pictured to the right) and that were cc'd to other persons at the company requesting to ask questions during the call about the company's establishment of an improper "cookie jar reserve" in Q3 2008 to materially overstate it financial performance in later quarters. Instead, Byrne stonewalled me in his responses to my emails.

In any case, I dialed into the call, identified myself to the operator, and Patrick Byrne was aware of my presence on the call. When they requested questions from the participants, I dialed *1 as instructed by them. The company took questions from other participants in the call. However, my attempts to ask important questions about the issues at hand were blocked by Overstock.com. Their statement that there were "no more questions" is a flat out lie. Patrick Byrne is simply afraid to answer my questions about Overstock.com's financial reporting violations in an open forum.

I had questions--and I have the answers, too. However, I am traveling to make a speech at the University of Massachusetts tomorrow. I will be exploring issues raised in the conference call and other public statements by management in a blog post when I return. In any case one thing is certain, Overstock.com has yet to produce a single financial report since the company's inception that has not violated Generally Accepted Accounting Principles (GAAP) or other SEC disclosure rules and its management continues to make false and misleading representations to investors in violation of rule 10b-5.

Written by:

Sam E. Antar

Note: Please read my guest article in Newsweek entitled, "Bernie Madoff's Giant Ponzi Scheme."

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. If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

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. In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me.