In August 2009, I wrote my first Open Letter to the Securities and Exchange Commission detailing how Overstock.com deliberately violated Generally Accepted Accounting Principles (GAAP) in recognizing income for recoveries from underbilled fulfillment partners by improperly claiming that a “gain contingency” existed under accounting rules. The SEC Division of Corporation Finance agreed with my reports and Overstock.com was eventually forced to restate its 2008 and 2009 financial reports to correct those GAAP violations.
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However, the SEC may not be aware that Overstock.com apparently lied about a certain key issue involving the timing of its decision to disclose that a purported "gain contingency" existed for potential recoveries from underbilled fulfillment partners. In addition, Overstock.com's other responses to SEC reviewers provide further evidence of deliberate attempt by the company to violate GAAP and establish an illegal "cookie jar" reserve to materially inflate future earnings (Q4 2008 to Q3 2009).
Since the Enforcement Division is investigating Overstock.com, they should take note of my analysis below.
Brief Background
On October 24, 2008, Overstock.com reported that it discovered customer refund and credit errors. On November 7, 2008, Overstock.com filed its Q3 2008 10-Q report and restated all prior affected financial reports from 2003 to Q2 2008 to correct such errors. Those customer refund and credit errors resulted in an additional $8.2 million of accumulated losses in prior reporting periods.
However, the customer refund and credit errors also caused Overstock.com to underbill its fulfillment partners for offsetting costs and reimbursements. While Overstock.com restated prior financial reports to correct its customer refund and credit errors, the company did not make offsetting corrections resulting from underbilling its fulfillment partners for certain reimbursements as required by GAAP.
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 and owed to the company from its fulfillment partners, less a reasonable estimate for uncollectable amounts. Instead, Overstock.com improperly recognized income from such underbillings as amounts due to the company was recovered on a non-GAAP cash basis in future accounting periods: Q4 2008, Q1, 2009, and Q2 2009. (See SFAS No. 154 and SFAS No 5 paragraph 1, 2, 8 and 23).
Therefore, Overstock.com overstated its customer refund and credit accounting error since the company failed to accrue offsetting fees and charges due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By deferring recognition of income until underbilled amounts were recovered, the company effectively created a "cookie jar" reserve to increase future earnings.
For example, Overstock.com improperly reported a Q4 2008 net profit of $1.014 million instead of a properly reported Q4 2008 net loss of $705k as a result of its improper recognition of income from recoveries of underbilled amounts owed by its fulfillment partners.
Overstock.com claimed that a "gain contingency" existed
On February 24, 2009 Overstock.com filed its 2008 10-K report and for the first time the company claimed that a "gain contingency" existed for any potential recoveries from its fulfillment partners:
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). [Emphasis added.]
Therefore, Overstock.com claimed that it could recognize income as it recovered underbilled amounts from its fulfillment partners in future reporting periods, rather than restate its financial reports to reflect when such underbilled amounts were actually earned by the company during previous accounting periods.
On January 29, 2010, Overstock.com finally admitted that its claimed gain contingency was "inappropriate" under accounting rules, as I correctly reported in my blog:
Once discovered, the Company applied “gain contingency” accounting for the recovery of such amounts, which it has now determined was an inappropriate accounting treatment.
Overstock.com's conflicting explanation to the Division of Corporation Finance
Overstock.com did not disclose that a "gain contingency" existed for potential recoveries from underbilled fulfillment partners in its Q3 2008 10-Q report (when the company restated its financial reports to correct customer refund and credit errors). The company waited until it filed its subsequent 2008 10-K report to finally claim that a gain contingency existed.
On October 1, 2009, SEC Division of Corporation Finance reviewers wanted to know why Overstock.com did not report the purported gain contingency in its Q3 2008 10-Q report:
Also, tell us why your September 30, 2008 Form 10-Q did not disclose a gain contingency. Refer to paragraph 17.b of SFAS No. 5.
On October 20, 2009, Overstock.com responded as follows:
At the time we filed our September 30, 2008 [Q3 2008] Quarterly Report on Form 10-Q, we had just completed our analysis of the under billing problem and had not yet commenced substantive discussions with our partners with respect to our potential recoveries of the under billed amounts. We believe that it would have been inappropriate to disclose a gain contingency. SFAS No. 5, paragraph 17(b) or ASC 450-30-50 states that, “adequate disclosure shall be made of contingencies that might result in gains, but care shall be exercised to avoid misleading implications as to the likelihood of realization.” Given the situation described above and the uncertainties of the recoveries, we determined that it would have been inappropriate under SFAS No. 5 to disclose a gain contingency at this early stage of the process. [Emphasis added.]
Overstock.com had filed its Q3 2008 10-Q report on November 7, 2008. The company claimed to the SEC reviewers that as of that date "...it would have been inappropriate to disclose a gain contingency."
However, Overstock.com's annual 2008 10-K report made a conflicting claim that a reportable gain contingency had already existed as of November 7, 2008:
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. [Emphasis added.]
The underbilling was "originally discovered" months before Overstock.com filed its Q3 2008 10-Q report on November 7, 2008. The company's subsequently filed 2008 10-K report claimed that "When the underbilling was originally discovered, we determined that...the potential recoveries constituted a gain contingency."
Therefore, Overstock.com's 2008 10-K report claimed that a reportable "gain contingency" existed as of November 7, 2008. However, the company contradicted itself and claimed to the SEC reviewers that reportable reportable "gain contingency" did not exist on November 7, 2008.
If Overstock.com's 10-K disclosure is true, the company's explanation to the SEC Division of Corporation Finance can't be true. Likewise, if Overstock.com's explanation to the SEC Division of Corporation Finance is true, the company's 2008 10-K disclosure can't be true.
What I believe happened
I believe that when Overstock.com filed its Q3 2008 10-Q report in November 2008, the company had not yet thought of using a gain contingency as justification for its improper accounting of recoveries from underbilled fulfillment partners.
In my August 5, 2009 Open Letter to the Securities and Exchange Commission, I reported that Overstock.com "apparently played a game of catch up" and concocted the "gain contingency" excuse in its 2008 10-K report to "rebut" previous "criticism in my blog" of Overstock.com's improper accounting for recoveries from fulfillment partners
SEC reviewers rejected Overstock.com's "gain contingency" claim
In its 2008 10-K report, 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.
Overstock.com told SEC reviewers that:
During the first two weeks of November, we began to contact partners to notify them of the under billing issue and to begin our negotiations with each one regarding the possibility of recovering certain of the under billing amounts. We provided to each partner a detail of the net under billing transactions so that they could review and respond to us regarding any questions or concerns. In our original correspondence, we offered to forgive all 2007 under billing amounts if they would negotiate with us for the under billing amounts related to 2008. We also offered to deduct these amounts from our remittances to partners from our future sales of their products on our website. For the few larger fulfillment partners with net under billings greater than $20,000 during 2008, we set up conference calls with our SVP of Finance and SVP of Merchandising to contact each fulfillment partner directly to discuss the issues, answer any questions and negotiate.The SEC reviewers rejected that excuse:
We also noted approximately half of your total 2008 under billings were comprised of 28 partners with balances in excess of $20,000. We assume you had historical revenue data from these partners which would have afforded you the ability to determine how long it would have taken to recover these under billings or assess the realization of the amounts owed to you, assuming you closely track sales data for your largest partners. We calculated you recovered approximately 67% of the 2008 under billings in the fourth quarter of 2008, and by the end of the first quarter of 2009 you collected approximately 84% of the under billings related to 2008. Notwithstanding the above comments, it appears the collection of under billings was reasonably assured as of December 31, 2008. [Emphasis added.]
According to the SEC's calculations, Overstock.com "...recovered approximately 67% of the 2008 under billings in the fourth quarter of 2008" or within a mere six weeks. Therefore, the SEC felt that "collection of under billings was reasonably assured as of December 31, 2008" and the company could not claim that a "gain contingency" existed in its 10-K report.
A question for Overstock.com
As I detailed above, Overstock.com filed its Q3 2008 10-Q on November 7. The 10-Q report was not due until November 15. Overstock.com claimed that:
During the first two weeks of November, we began to contact partners to notify them of the under billing issue and to begin our negotiations with each one regarding the possibility of recovering certain of the under billing amounts.Why didn't the company simply file a "Notification of Late Filing" with the SEC and get even more time to properly complete its Q3 2008 10-Q report?
That would have been the conservative thing to do.
My conclusion
Apparently, Overstock.com did not want to restate its financial reports and needed any excuse to use recoveries from underbilled fulfillment partners to materially inflate future earnings starting in Q4 2008. That's why Overstock.com told one story to investors in its 2008 10-K report and later told a different story to SEC reviewers. In other words, Overstock.com wanted to create an illegal "cookie jar" reserve to overstate future earnings.
Written by:
Sam E. Antar
Note: See important disclosure under list of previous open letters to the SEC.
Blog Reaction:
June 29, 2010: Going Concern - Were PwC and Grant Thornton Ignoring Overstock.com’s Accounting Issues? by Caleb Newquist
Recommended reading about my recent issues with the SEC over a certain subpoena:
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June 22, 2010: Columbia Journalism Review: The SEC Is After Two Dow Jones Journalists' Emails by Ryan Chittum
June 23, 2010: Business Insider - SEC Has Launched Investigation Of InterOil (IOC) Skeptics And Wants Their Emails To The Media by Henry Blodget
June 23, 2010: Reuters - When the SEC subpoenas journalists’ sources by Felix Salmon
June 28, 2010: The Reporters Committee for Freedom of the Press - SEC subpoenas target whistleblowers' e-mail to reporters by Ellen Biltz
My previous open letters to the SEC (please note that each letter is based on Overstock.com's deliberately vague, incoherent, and inconsistent, and often contradictory disclosures at the time each one was issued):
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
11/23/09: Open Letter to the Securities and Exchange Commission Part 3: Overstock.com Lied About Grant Thornton and Concealed Error
11/26/09: Open Letter to the Securities and Exchange Commission Part 4: Patrick Byrne Ignores Real Issues As He Vilifies Grant Thornton
12/14/09: Open Letter to the Securities and Exchange Commission Part 5: Issuer Retaliation Complaint Against Overstock.com
01/03/10: Open Letter to the Securities and Exchange Commission Part 6: Conflicting Disclosures by Overstock.com Reveal Improper Audit Opinion Shopping
02/02/10: Open Letter to the Securities and Exchange Commission Part 7: Why Overstock.com and David Chidester Parted Ways
04/05/10: Open Letter to the Securities and Exchange Commission Part 8: Bring Enforcement Action Against Overstock.com for False and Misleading Disclosures
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 committed my crimes in cold-blood for fun and profit, and simply because I could.
If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney'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.
There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.
Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).
In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.
I do not own Overstock.com or Bidz.com securities long or short. My exposure of confirmed financial reporting violations by Overstock.com and possible financial reporting violations by Bidz.com was a freebie to securities regulators to get me into heaven, though I doubt that I will ever get there.
I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.
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