Sunday, June 27, 2010

Open Letter to the Securities and Exchange Commission Part 9: Overstock.com's Excuses Simply Don't Add Up

To SEC Chairperson Mary Schapiro:

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.

CEO Patrick Byrne after drinking it up
The Division of Corporation Finance reviewers did a superb job in carefully examining Overstock.com's financial disclosures. The SEC reviewers rejected each and every excuse put forth by Overstock.com in its desperate effort to avoid restating its financial reports for the third time in three years.

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).
Note: Bold print and italics added by me.
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.

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

Note: Bold print and italics added by me.
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.
Note: Bold print and italics added by me.
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:

Featured in Portfolio.com
June 22, 2010: Portfolio.com - SEC Crazy Talk by Gary Weiss

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.

Tuesday, June 22, 2010

If You Question Medifast's Revenue Accounting, Expect a Subpoena Rather Than a Rebuttal

Rather than respond to my Open Letters to the Securities and Exchnage Commission raising serious questions about Medifast's (NYSE: MED) compliance with Generally Accepted Accounting Principles (GAAP) and SEC Topic 13 governing revenue recognition, the company has decided to subpoena me as a third party witness in its ongoing litigation with Fraud Discovery Institute, co-founded by convicted felon turned successful fraud buster Barry Minkow.

Starting in January 2009, Fraud Discovery Institute released a series of detailed investigative reports alleging potentially serious improprieties concerning Medifast's business model, marketing practices, and financial disclosures to investors in reports filed with the SEC. In addition, Barry Minkow openly disclosed that he has held a short position in Medifast securities, hoping to profit from the decline in the company's stock price (perfectly legal).

In February 2010, Medifast filed a multi-million dollar lawsuit alleging defamation by Fraud Discovery Institute, its co-founder Barry Minkow, pyramid scheme expert Robert L. FitzPatrick, acclaimed forensic accountant and book author Tracy Coenen, best-selling author and former investigative journalist William Lobdell (who now writes for iBusiness Reporting, a blog funded by Fraud Discovery), and an anonymous Yahoo massage board poster. The defendants have since filed, what is known as, Anti-Slapp motions claiming that Medifast is attempting to limit their First Amendment right of free speech under the United States Constitution.

Back in 2007, Fraud Discovery alleged fraud at Usana (NYSE: USNA) and the company sued Minkow for libel. All the libel counts were thrown out by a federal judge who then ordered Usana to pay Minkow’s legal fees. Likewise, the defendants are confident that Medifast's lawsuit will be dismissed, too.

Rather than provide any detailed rebuttal of Fraud Discovery's allegations, Medifast CEO Michael C McDevitt has resorted to personal attacks against Minkow:
We believe most everything he says to be false and made for his own personal gain. He is a liar and can't be trusted.
Other than say that Fraud Discovery's allegations are false in its lawsuit and the press, Medifast has yet to provide a detailed line-by-line rebuttal of any allegation made in Minkow's reports. Minkow has asked for such a rebuttal and offered to correct any possible errors. What's Medifast afraid of?

Instead, Medifast has complained to the SEC and the regulator is now probing Minkow. Portfolio.com columnist Gary Weiss asked:
What in heaven’s name is the SEC thinking? Is it completely out to lunch?”
Weiss continues:
What is going on here? Well, I think what we may be seeing is a repeat of the Einhorn fiasco, and then some.
Both Einhorn and Minkow are short-sellers, profiting from their probes into the finances of companies. Short-sellers provide an undeniable benefit for the markets and perform a function that the SEC often fumbles: Shorts, and whistleblowers like Antar, police the financial statements of companies, providing a skeptical view of stocks that they believe are overvalued or otherwise flawed. Antar takes pride in the accounting goofs and crookedness that he has brought to the SEC’s attention, directly and through his blog.
SEC investigations are like unguided missiles. In case after case, the SEC usually ends up clearing whistleblowers like Minkow and Einhorn and finding securities violations committed by complaining companies.

The same happened with Overstock.com. The SEC cleared independent research firm Gradient Analytics and short seller Copper River Management, formerly Rocker Partners. Overstock.com and its CEO are under current investigation by the SEC as a result of GAAP violations exposed in this blog that caused the company to restate its financial reports for the third time in three years. (Read Richard Sauer's book entitled, "Selling America Short: The SEC and Market Contrarians in the Age of Absurdity.")

For Minkow to be wrong, Medifast has to prove that it is right and that's where the real fun begins. Medifast will have to put up or shut up and risks the SEC possibly finding Minkow's allegations of improprieties are correct.

In my case, Medifast remains strangely silent in responding to questions raised in my open letters to the SEC about the company's compliance with accounting rules governing revenue recognition. It looks like the folks at Medifast have no balls.

Likewise, I filed a whistleblower tip to the SEC and the regulator assures me that they will investigate Medifast's revenue accounting practices. I even got a thank you letter!

Written by:

Sam E. Antar

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I 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.

In the past, I was compensated by Fraud Discovery Institute to do certain research on InterOil and Medifast's auditors. However, I do not own InterOil or Medifast securities long or short. Fraud Discovery Institute, co-founder, Barry Minkow has publicly disclosed that he has held short positions in InterOil and Medifast securities. However, I am unaware if he has any position in InterOil or Medifast at this time.

I posted this open letter on my blog simply because I could - for fun and enjoyment. In America, even convicted felons like me have rights under the First Amendment to the US Constitution. If anyone has any complaints, please ask your elected officials to change the Constitution, feel free to complain to the SEC, take other legal measures, or rant, yell and scream. I personally don't give a damn.

Sunday, June 20, 2010

Open Letter to the Securities and Exchange Commission: Is Medifast Complying with Revenue Accounting Rules?

To Securities and Exchange Commission Chief Accountant Wayne Carnall:

In my first Open Letter, I asked the Securities and Exchange Commission Division of Corporation Finance to review Medifast's (NYSE: MED) revenue recognition policy to determine if it complies with Generally Accepted Accounting Principles (GAAP) and SEC Staff Accounting Bulletin Topic 13. In my second Open Letter, I promised the SEC "Forensic accounting in real time!" In this third open letter, I will deliver on that promise and provide you an updated analysis of Medifast's revenue accounting.

As I will detail below, a careful analysis of Medifast's disclosures to investors and customers raise a very serious question about the company's compliance with revenue accounting rules going back to 2004 and suggest that the company is possibly recognizing revenue up to 8 business days too early.

Chronology of Medifast's Revenue Recognition Disclosures

On March 14, 2005, Medifast filed its 10-KSB report for fiscal year 2004 with the SEC. The company reported its revenue recognition policy as follows:
[9] REVENUE:

Revenue from sales is recognized when the product is shipped to customers or purchased by wholesale customers.
Note: Bold print and italics added by me.
Medifast recognized revenue when product was shipped to its customers. However, revenue can only be recognized on the shipment date when certain conditions are met, such as the passing of risk by the company to its customers.

SEC reviewer asks for a clarification

On April 11, 2005, the SEC Division of Corporation Finance sent Medifast a comment letter and asked the company to clarify its revenue recognition disclosure:
[9] - Revenue

4. We note the disclosure of your revenue recognition accounting policy. Expand your disclosures to address all the criteria to be met for revenue recognition as discussed in Staff Accounting Bulletin Topic 13. If certain industry-specific authoritative guidance applies, discuss your policies with regard to the application of that literature.
Note: Bold print and italics added by me.
The SEC reviewer asked Medifast the above question on April 11 and 35 days later on May 16, Medifast still could not answer the above question.

Medifast delays response to SEC

On May 16, 2005, Medifast asked the SEC for a "5-day extension" to respond to its comment letter and gave the following excuse:
I am writing request a 5-day extension on our SEC comment letter dated April 11, 2005. Having been consumed with work related to our recent filing of Form 10-Q on May 10, 2005 we would appreciate additional time in order to properly address the comments. In addition, our President has been out of the country and our Controller has been on vacation for the last few days making the completion of the SEC comment letter difficult. Thank you very much for your consideration.
Medifast finally responds to SEC

On May 21, 2005 Medifast finally responded to the April 11 SEC comment letter, 40 days later:
Note B - Significant Accounting Policies, page F-8

We have amended our disclosure on Form 10-KSB/A to address all the criteria discussed in Staff Accounting Bulletin Topic 13. Our disclosure is as follows:

"Revenue is recognized for product sales upon shipment and passing of risk to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. Estimated sales returns, allowances and discounts are provided for."
Note: Bold print and italics added by me.
In other words, Medifast claimed that "upon shipment" the risk of ownership passes to its customers and the company had "no further performance obligations" to them. Therefore, the company claimed that it is permitted to recognize revenue on the shipment date under SEC rules.

In the years that followed, Medifast's revenue recognition disclosure stayed pretty much the same as its revenue recognition disclosure in 2005. According to the company's 2009 10-K report:
Revenue Recognition. Revenue from product sales is recognized net of discounts, rebates, promotional adjustments, price adjustments, returns and other potential adjustments upon shipment and passing of risk to the customer and when estimates of are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations.
In both cases, other than changes in sentence structure, revenue from product sales are recognized "upon shipment and passing of risk to the customer."

As I will describe below, the "passing of risk to the customer" is a key issue in determining when to recognize revenue under accounting rules. If risk, in substance, does not pass to the customer on the shipping date, Medifast cannot record revenue on that date and the company is reporting revenue, too early.

Let's examine SEC rules governing revenue recognition.

SEC Staff Accounting Bulletin Topic 13 (SAB Topic 13) governing revenue recognition

According to SEC Staff Accounting Bulletin Topic 13:
The staff believes that revenue generally is realized or realizable and earned when all of the following criteria are met:

Persuasive evidence of an arrangement exists,
Delivery has occurred or services have been rendered,
The seller's price to the buyer is fixed or determinable, and
Collectibility is reasonably assured.

Note: Bold print and italics added by me.
All the above four conditions must be met before revenue can be recognized.

In addition, the SAB Topic 13 noted:
The Commission has set forth criteria to be met in order to recognize revenue when delivery has not occurred. These include:

1. The risks of ownership must have passed to the buyer;
Note: Bold print and italics added by me.
In determining whether "risks of ownership" have passed to the buyer or customer for purposes of revenue recognition, the SEC requires public companies to consider the "substance" of a transaction over its "legal form" - the basic underlying principle of GAAP.

Applying "substance over form"

For example, in December 2007, the SEC Division of Corporation Finance reviewed Overstock.com's (NASDAQ: OSTK) revenue recognition policies. Overstock.com recognized revenue on the shipment date because legal title (in legal form, rather than substance) passed at point of shipment.

The company explained to the SEC reviewer:
Although we have no legal obligation to compensate the customer for goods that are lost or damaged in transit, it is industry practice (and is required by the carrier since items are shipped on our account with the carrier) that we act as the liaison between the customer and the carrier if a product is lost or damaged in transit. Therefore, we generally replace the product or reimburse the customer for goods lost or damaged in transit, and then subsequently file a claim for reimbursement from the carrier.
Note: Bold print and italics added by me.
However, the SEC Division of Corporation Finance rejected Overstock.com's argument by applying the basic principle of "substance over form" underlying GAAP:
...in your response, in substance, risk of loss does not transfer to the customer at point of shipment, but instead transfers to the customer upon delivery and acceptance. Since assumption for risk of loss is a significant obligation during the delivery process, we are not persuaded that you should recognize revenue before the delivery process is complete. Please revise disclosure of your accounting policy accordingly to clarify that risk of loss transfers to the customer upon delivery and acceptance for all sales at which time revenue is recognized. Please revise your financial statements accordingly to reflect revenue being recognized based on delivery to the customer for all periods presented and provide the disclosures required by SFAS 154 for correction of an error.
Note: Bold print and italics added by me.
Overstock.com was required to report an accounting error because the company was recognizing revenue at the point of shipment, instead of its delivery date. In the addition, the SEC required Overstock.com to clarify and expand its revenue accounting disclosures.

When should Medifast recognize revenue?

Likewise Medifast's return policy also appears "in substance" to transfer risk of loss to the customer on the delivery date and not the product shipment date. As of the shipment date, Medifast still has "significant" obligations to perform for its customers, since the company still handles issues related to: returns associated with substandard product or errors, damaged goods, shipping errors, order cancellation, and theft losses before delivery. See excerpts from Medifast's return policy below:
Returns Associated with Substandard Product or Errors
• In the event that Medifast ships consumable products with defects or products that were not part of the order, Medifast will issue the customer a Return Merchandise Authorization (RMA) number and shipping labels so that the items in question can be returned at the company’s expense. Customers should report such issues and request RMA’s by calling 800-638-7867. Upon receipt of returned shipment, Medifast conducts a Quality Assurance test to determine appropriate resolution. If the customer receives defective non-consumable goods, the company will send replacement. Shipping charges related to original order will not be refunded.

[snip]
Damaged Goods
• If a package arrives damaged and unacceptable, Medifast must be notified within fifteen (15) days of purchase. If notification is not given within fifteen (15) days, no claim will be placed with the shipping agent, and replacement products will not be shipped for the damaged package.

Shipping Errors
• If a package is shipped to the wrong destination and it is the company’s error, the company will pay to have the package shipped to the proper location. Medifast will ship expedited freight for any products needed immediately (i.e. customer is out of supplements completely), but will ship UPS Ground for all other products. If the error is on the client’s part, they must make their own arrangements to send the shipment back to Medifast in order to receive credit. If the shipping agent (i.e. Federal Express, UPS, USPS) has delivered the shipment inaccurately, Medifast will send shipping labels to the customer. The customer will then bring the package to a shipping provider to have it returned to Medifast.
Order Cancellation
• If a request for cancellation occurs after the order has been shipped; the customer will be instructed to refuse the package. Cost of products will be refunded however the customer is responsible to pay for shipping and handling.
Theft Losses
• If a package is stolen from a doorstep, Medifast will ship a replacement order which will require a signature upon delivery. This policy applies to one occurrence of theft only. Medifast will investigate the theft of the original package and file a claim with the shipping agent. Medifast reserves the right to refuse replacement shipments based on customer history at any time.
An examination of the Adobe pdf document downloaded from Medifast's website indicates that such document was created on "7/12/06." Note: The "Modification date" is the date which document is downloaded from Medifast's website and is not applicable here.

Therefore, at least starting in 2006, it appears that Medifast "in substance" transferred risk of loss to the customer on the delivery date and not the product shipment date. Since it appears that Medifast still had significant obligations to perform for its customers upon shipment, the company is required to recognize revenue on the delivery date and not the shipping date.
.
Medifast's discloses on its website:
What is your shipping policy?
Allow five to seven business days for standard shipping, or three to four business days for expedited shipping (additional charge).
Medifast delivers is product to customers from three to seven business days after shipment. If Medifast is actually recognizing revenue on the shipment date to its customers, the company is probably prematurely recognizing revenue three to seven business days too early - at least as far back as 2006.

Medifast's financial disclosures omit mention of any deferred revenue liabilities

Setting aside whether Medifast should recognize revenue upon shipment date or delivery date, the company must report a deferred revenue liability for customer orders processed and not yet shipped or delivered prior to the end of a reporting period. Otherwise, the company prematurely recognizes revenue under GAAP.

According to Medifast's shipping policy, "All orders are processed within 24 hours and shipped the next business day." However, Medifast's financial reports seem to omit any "deferred revenue" liability disclosure for customer orders processed but not yet shipped.

If Medifast processes an order from a customer prior to the end of a reporting period, but does not ship or deliver the product until the next reporting period, the company should report a "deferred revenue" liability to its customer instead of revenue, because it still has an obligation to perform services for that customer.
However, Medifast's financial reports going back to 2004 disclose no deferred revenue liabilities for customer orders processed before each fiscal year ended and either shipped or delivered after those respective fiscal years.

Starting in 2004, Medifast omitted reporting deferred revenues as a sub-item under “Accounts payable and accrued expenses. See excerpt from Medifast’s 2004 10-KSB report below:


From 2005 to 2009, Medifast omitted any mention of deferred revenues as a sub-item of "Account payable and accrued expenses." For example, see the excerpt from Medifast's 2009 10-K report below:


If deferred revenue liabilities were no longer being reported as a sub-item of "Accounts payable and accrued expenses" reason follows that it would be reported as a separate line item under the "current liabilities" section of Medifast's balance sheet. However, from 2005 to 2009, Medifast's current liability section of its balance sheet from 2004 to 2009 omits any mention of deferred revenue liabilities. See example for Medifast's 2009 10-K report below:


Sometimes companies will report deferred revenues as an offset against "Current assets" on their balance sheets. However, I examined Medifast's current asset disclosures and found no information about deferred revenues being used to offset any current asset accounts.

If Medifast actually reported deferred revenues as an offset to any current asset account, such an offset would be against the accounts receivable account. However, Medifast's "accounts receivable and allowance for doubtful accounts" disclosures omit any reference to reporting deferred revenues as an offset to accounts receivable.

For example, see Medifast's "accounts receivable and allowance for doubtful accounts" disclosure from the company's 2009 10-K report below:
Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded net of reserves for sales returns and allowances, and net of provisions for doubtful accounts. Allowances for sales returns and discounts are based on an analysis of historical trends, and allowances for doubtful accounts are based primarily on an analysis of aging accounts receivable balances and on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.
The "allowance for sales returns and doubtful accounts" which offsets accounts receivable was a mere $100,000 at the end of fiscal year 2009 and 2008. Just in case the company included deferred revenues as part of that account without disclosing it, the $100,000 reported for such an allowance does not seem reasonable enough given Medifast's volume of revenues and the dates it either ships or delivers its orders to customers after processing them.

Key issues - Red Flags

According to Medifast's shipping policy, "All orders are processed within 24 hours and shipped the next business day." However, since 2004, Medifast's financial disclosures apparently omit any reference to "deferred revenue" liabilities which reflect the company's obligation for unshipped products to its customers at the end of each accounting period. At the very least, it appears that Medifast is recognizing revenue a business day early.

Since at least 2006, it appears that Medifast, in substance, effectively transfers risk of loss to the customer on the date of delivery, rather than when the product is shipped. Medifast ships its products to its customers on the next business day after its processing the customer's order. Those products are delivered to its customers three to seven business days later. In other words, Medifast is possibly recognizing revenue four to eight business days early.


Materiality
 
If the SEC determines that Medifast violated revenue recognition rules, SEC
Staff Accounting Bulletin No. 99, requires the company to perform a quarter-by-quarter analysis to determine the impact of the accounting error on earnings, earnings trends, and whether such error caused the company to beat analyst earnings expectations.

I do not have enough information from publicly available sources to determine if Medifast's potential revenue recognition issues are material enough to cause a restatement of its financial reports. At the very least, it appears that Medifast would be required to record a one-time cumulative adjustment in its latest financial report to correct previously reported revenues and earnings.

According to SEC
Staff Accounting Bulletin No. 99
, registrants are not permitted to make intentional immaterial misstatements "in a manner inconsistent with GAAP." See below:
Immaterial Misstatements That are Intentional

Facts: A registrant's management intentionally has made adjustments to various financial statement items in a manner inconsistent with GAAP. In each accounting period in which such actions were taken, none of the individual adjustments is by itself material, nor is the aggregate effect on the financial statements taken as a whole material for the period. The registrant's earnings "management" has been effected at the direction or acquiescence of management in the belief that any deviations from GAAP have been immaterial and that accordingly the accounting is permissible.

Question: In the staff's view, may a registrant make intentional immaterial misstatements in its financial statements?

Interpretive Response: No. In certain circumstances, intentional immaterial misstatements are unlawful.
Therefore, a public company cannot recognize revenue "in a manner inconsistent with GAAP" even if "any deviations from GAAP have been immaterial."

Even relatively small immaterial misstatements of revenue can cause disproportionately larger material misstatements of reported earnings. For example, Overstock.com CEO Patrick Byrne told the Associated Press that certain GAAP violations uncovered in this blog:
...involved 0.1 percent of revenue and gave the company no advantage.
However, the GAAP violation caused the company to report an improper Q4 2008 profit, instead of a properly reported loss.

A departure from GAAP is considered a material reportable event, even if it does not result in a restatement of financial reports or a one-time cumulative adjustment to financial reports to correct such a violation.

Closing comments

In my analysis above, I have presented a reasonable basis for concern that Medifast's revenue recognition policy possibly violates GAAP and SEC rules under SAB Topic 13. All public company financial reports are subject to a limited review by the SEC Division of Corporation Finance on a periodic basis (usually every three years). Medifast's last review was in 2007 and a new review is now due. I respectfully urge you to promptly review Medifast's revenue recognition policies before the company issues its Q2 2010 report sometime in late July or early August.

Respectfully,

Sam E. Antar

Note: The self-proclaimed "distinguished" people at Medifast are still invited to provide this convicted felon with a detailed line-by-line response to the analysis provided above and I will post their full response on my blog. I am simply using Medifast's own disclosures to investors and customers as a basis for expressing my reasonable concerns. If there is any confusion on my part, Medifast should clarify its financial disclosures and make them more transparent.

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.

In the past, I was compensated by Fraud Discovery Institute to do certain research on InterOil and Medifast's auditors. However, I do not own InterOil or Medifast securities long or short. Fraud Discovery Institute, co-founder, Barry Minkow has publicly disclosed that he has held short positions in InterOil and Medifast securities. However, I am unaware if he has any position in InterOil or Medifast at this time.

I posted this open letter on my blog simply because I could - for fun and enjoyment. In America, even convicted felons like me have rights under the First Amendment to the US Constitution. If anyone has any complaints, please ask your elected officials to change the Constitution, feel free to complain to the SEC, take other legal measures, or rant, yell and scream. I personally don't give a damn.

Thursday, June 17, 2010

Open Letter to the Securities and Exchange Commission: Can a Convicted Felon Help You Find Financial Reporting Violations?

To the Securities and Exchange Commission Chief Accountant Wayne Carnall:

In my previous Open Letter, I asked the Securities and Exchange Commission Division of Corporation Finance to review Medifast's (NYSE: MED) revenue recognition policy to determine if it complies with Generally Accepted Accounting Principles (GAAP) and SEC Staff Accounting Bulletin Topic 13: A. While I made no allegations of non-compliance with accounting rules, I am concerned about the possibility that Medifast may have prematurely recognized revenue based on a detailed analysis of the company's vague and skimpy financial disclosures.

After all, who am I to make such an allegation against Medifast's "...distinguished board of directors and executive team is populated with members of the U.S. military, the clergy, academia, and the legal profession," since I am a just a convicted felon like my dear friend Barry Minkow, lest I be possibly sued by the company and investigated by the SEC, like Minkow, at the instigation of these "distinguished" men for daring to critique their company? I'd much rather ask the hard working people at the SEC who wisely listened to me about Overstock.com, to get to the bottom of this issue concerning Medifast.

Convicted felons can't be right or can they? Does it not matter that I was right and Overstock.com (NASDAQ: OSTK), its management, its audit committee, and its auditors were all wrong when I correctly identified now confirmed GAAP violations by the company that caused it to restate its financial reports for the third time in three years. Yet, Overstock.com's CEO Patrick M. Byrne has called me "Sam the crook" and his company's website still identifies me as an "anti-Overstock.com" blogger. No good deed goes unpunished, but I digress.

Perhaps, the above "distinguished" people at Medifast can issue a line-by-line response to my analysis as I invited them to do in my last open letter? Are they pussies? Nah, not them. They all call themselves "distinguished" men.

Warning: Antar plays poker with a marked deck. For reference, just ask Overstock.com CEO Patrick Byrne and those hard working people who listened to me at the SEC and are now investigating his company.

To be continued in Open Letter to SEC - Part 3. Forensic accounting in real time!

Update: Part 3 - Open Letter to the Securities and Exchange Commission - Is Medifast Complying with Revenue Accounting Rules?

Respectfully:

Sam E. Antar

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I 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 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.

In the past, I was compensated by Fraud Discovery Institute to do certain research on InterOil and Medifast's auditors. However, I do not own InterOil or Medifast securities long or short. Fraud Discovery Institute, co-founder, Barry Minkow has publicly disclosed that he has held short positions in InterOil and Medifast securities.

I posted my open letters on my blog simply because I could - for fun and enjoyment. In America, even convicted felons like me have rights under the First Amendment to the US Constitution. If anyone has any complaints, please ask your elected officials to change the Constitution, feel free to complain to the SEC, take other legal measures, or rant, yell and scream. I personally don't give a damn.

Finally, I still invite Medifast to publish a detailed line-by-line response to my concerns and I will post such response on my blog.

Tuesday, June 15, 2010

Class Action Complaint against Amedisys uses Sarbanes-Oxley Act Corporate Governance Provisions to Battle Alleged Corporate Malfeasance

Updated at bottom of article

Last week, Pomerantz Haudek Grossman & Gross LLP filed a class action lawsuit against Amedisys (NASDAQ: AMED) charging the company, its CEO William F. Borne and its CFO Dale E. Redman with securities fraud.  In the next few days, Bernstein Liebhard LLP and Finkelstein Thompson LLP filed similar class action lawsuits against the company. The lawsuits allege that Amedisys abused Medicare's reimbursement system for at-home therapy care based on a compelling analysis of company revenues in an April 27 Wall Street Journal article.

In addition, the lawsuits innovatively utilize a provision under Section 406 of the Sarbanes-Oxley Act 2002 which provides a back-door way for investors to force ethical corporate governance and sue public companies for malfeasance. That provision requires Senior Financial Officers, such as the CEO and CFO of public companies, to abide by a strict code of ethics which broadly defines corporate malfeasance and effectively makes it easier for defrauded investors to prove misconduct by certain senior executives. Suing public companies for code of ethic violations can be a potent tool to insure good corporate governance and conduct.

Allegations that Amedisys intentionally increased patient visits to trigger higher Medicare reimbursements

According to the Pomerantz press release:
Specifically, the Complaint alleges that defendants made false and/or misleading statements and/or failed to disclose: (1) that the Company's reported sales and earnings growth were materially impacted by a scheme whereby the Company intentionally increased the number of in-home therapy visits to patients for the purpose of triggering higher reimbursement rates under the Medicare home health prospective payment system, as those excess visits were not always medically necessary; (2) that the Company's reported sales and earnings were inflated by said scheme and subject to recoupment by Medicare; (3) that the Company was in material violation of its Code of Ethical Business Conduct and compliance due to the scheme to inflate Medicare revenues; and (4) based on the foregoing, defendants lacked a basis for their positive statements about the Company, its prospects and growth.

On April 27, 2010, The Wall Street Journal ("WSJ") reported that Amedisys has been taking advantage of the Medicare reimbursement system by increasing the number of in-home therapy visits in order to trigger additional reimbursements.
The alleged scheme whereby Amedisys "intentionally increased the number of in-home therapy visits to patients for the purpose of triggering higher reimbursement rates under the Medicare home health prospective payment system" is based on a troubling pattern of Medicare reimbursements detailed by the Wall Street Journal below:
Medicare reimbursements are determined in part by the number of at-home therapy visits each patient receives, with an extra fee kicking in as soon as a patient hits a certain number of visits. Between 2000 and 2007, Medicare paid companies a flat fee of about $2,200 for up to nine home therapy visits. It paid an additional reimbursement of roughly $2,200 if the therapy surpassed nine visits. That incentive was designed so that agencies didn't "stint" on therapy visits, says Laurence Wilson, the director of chronic-care policy group at the Centers for Medicare and Medicaid Services, the agency that runs Medicare.

According to The Journal analysis, which was based on publicly available Medicare records, Amedisys provided many of its patients just enough therapy visits to trigger the extra $2,200 payment. In 2005, 2006 and 2007, very few Amedisys patients received nine therapy visits while a much higher percentage got 10 visits or more. In 2007, for instance, only 2.88% of patients got nine visits, while 9.53% of patients got 10 visits.

"I was told 'we have to have ten visits to get paid,'" says Tracy Trusler, a former Amedisys nurse for two years in Tennessee, who has since left the company. Her supervisors, she says, asked her to look through patients' files to find those who were just shy of the 10-visit mark and call their assigned therapists to remind them to make the extra appointment.

"The tenth visit was not always medically necessary," Ms. Trusler says.
In other words, Amedisys had a financial incentive to increase the number of patient visits from 9 to 10 "to trigger the extra $2,200 payment." The Wall Street Journal’s analysis shows that number of patients getting 10 visits far outnumbered the number of patients getting just 9 visits by a relative factor of 3.5!

Lightening Never Strikes Twice in the Same Place

In January 2008, Medicare changed its reimbursement rules and according to the Wall Street Journal the pattern of patient visits likewise changed to maximize reimbursements to Amedisys. It was as if lightening stuck twice in the exact same place on different dates!  See below:
Medicare changed its reimbursement rules in January 2008 in an attempt to blunt the incentive for home health-care visits it created. It eliminated the $2,200 bonus payment at 10 visits and now pays an extra fee of a couple of hundred dollars at six, 14 and 20 therapy visits. "What we felt we could do is try to create some better incentives in the system for providing the level of service that beneficiaries actually needed," says Mr. Wilson from Medicare.

[Snip]

The Journal analysis found a similar pattern: In 2008, the percentage of Amedisys patients getting 10 visits dropped by 50%, while the percentage that got six visits increased 8%. The percentage of patients getting 14 visits rose 33% and the percentage getting 20 visits increased 41%.
In other words, Amedisys no longer had a $2,200 financial incentive to give 10 at-home therapy patient visits, so that number dropped by 50%. The company received a financial incentive from Medicare at 6, 14, and 20 visits and the patient's getting such number of visits rose dramatically.

On May 12, 2010, the Senate Finance Committee started an investigation questioning whether Amedisys "intentionally increased utilization for the purpose of triggering higher reimbursements" and cited the Wall Street Journal article above.

Stuck Between a Rock and a Hard Place

Amedisys is stuck between a rock and a hard place. If the same patterns of Medicare reimbursements continue in Q2 2010, the company will be accused of continuing to abuse Medicare's reimbursement system. If those Medicare reimbursement patterns don’t continue, the critics will claim that the company changed its behavior after getting exposed by the Wall Street Journal.

Allegations that Amedisys violated its Code of Ethical Business Conduct

Perhaps the most interesting aspect of the class action lawsuits are allegations that Amedisys "was in material violation of its Code of Ethical Business Conduct and compliance due to the scheme to inflate Medicare revenues."

Under Section 406 of the Sarbanes-Oxley Act 2002, public companies are required to have a strict code of ethics covering its senior financial officers (principal executive officer, principal financial officer, principal accounting officer) and such companies must disclose any changes, waivers, or violations of their codes of ethics.

SEC rules broadly define the term “code of ethics” as:
… written standards that are reasonably designed to deter wrongdoing and to promote:
Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

Full, fair, accurate, timely, and understandable disclosure in reports and documents that a registrant files with, or submits to, the Commission and in other public communications made by the registrant;
Compliance with applicable governmental laws, rules and regulations;

The prompt internal reporting to an appropriate person or persons identified in the code of violations of the code; and

Accountability for adherence to the code.
An article entitled “Corporate Ethics and Sarbanes-Oxley” (article first appeared in Wall Street Lawyer – July 2003) by Frank Navran and Edward L. Pittman, re-published on Ethics.org, explained how Sarbanes-Oxley broadly expanded the scope of unacceptable corporate behavior under securities laws:
Of the five elements of the Commission's code, the only one that is specific to public companies relates to accuracy and timeliness of disclosure in public filings and other public communications. A more general statement of the requirement may be expressed as the value of "honesty." Honesty, for example, includes being candid, open, truthful, and free from deception and deceit--telling the truth, even when doing so may be difficult, and being forthcoming with all relevant facts and information. The core principle of telling the truth and coming forward with information in internal discussions is important.
SEC rules require public companies to promptly disclose any "amendments to, and waivers from, their ethics codes." If a public company fails to take prompt action regarding any possible material departures from its code of ethics by senior financial officers, SEC rules call it an "implicit waiver" which also must be disclosed to investors. See below:
2. For purposes of this Item:

a. The term "waiver" means the approval by the registrant of a material departure from a provision of the code of ethics; and

b. The term "implicit waiver" means the registrant's failure to take action within a reasonable period of time regarding a material departure from a provision of the code of ethics that has been made known to an executive officer, as defined in Rule 3b-7 (§240.3b-7 of this chapter) of the registrant
As I detailed above, SEC rules define, "code of ethics" as “…written standards that are reasonably designed to deter wrongdoing and to promote Honest and ethical conduct…” If a senior financial officer (CEO or CFO) of a public company is dishonest or engages in unethical conduct and the company fails to act on such misconduct, it is considered an “implicit waiver.” Any waivers, even “implicit waivers” from a public company’s code of ethics by such officers are considered material reportable events.  A failure to report any such waivers violates securities law.

The SEC rules under Sarbanes-Oxley for public company codes of ethics broadly define corporate malfeasance by senior financial officers, requires such companies to promptly report any misconduct, prohibits companies from ignoring any misconduct, and makes it relatively easy for investors to sue for misconduct.

In the past, I’ve advocated holding Overstock.com (NASDAQ: OSTK) and its CEO Patrick Byrne accountable under Sarbanes-Oxley corporate governance rules for documented lies to investors, perennial GAAP violations, and stalking of critics. The SEC can take a lesson from the Amedisys complaint, too.

Hopefully, more lawsuits will cite code of ethics violations by public company senior financial officers in the future.

Written by:

Sam E. Antar

Update:

July 7, 2010: Open Letter to the Securities and Exchange Commission: Investigate Troubling Issues at Amedisys Missed by Wall Street Journal

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 investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here). In addition, the SEC is investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them 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. Lawsuits citing code of ethics violations will help me find plenty of company in hell.

I do not own any Amedisys securities long or short.

Sunday, June 13, 2010

Open Letter to the Securities and Exchange Commission: Why You Must Review Medifast's Revenue Accounting Disclosures

To the Securities and Exchange Commission Chief Accountant Wayne Carnall:

Based on my analysis of Medifast’s (NYSE: MED) financial disclosures below, I respectfully recommend that the Division of Corporation Finance immediately review the company’s revenue recognition policy, before it issues its Q2 2010 10-Q report. Medifast’s relatively vague revenue recognition policy and other skimpy disclosures give rise to reasonable questions concerning the company’s compliance with Generally Accepted Accounting Principles (GAAP) and SEC Staff Accounting Bulletin Topic 13: A.

Medifast's Revenue Recognition Policy

Medifast’s (NYSE: MED) revenue recognition policy is disclosed as follows in its various filings with the Securities and Exchange Commission (See 2009 10-K report pages 20 and 65):
Revenue Recognition. Revenue from product sales is recognized net of discounts, rebates, promotional adjustments, price adjustments, returns and other potential adjustments upon shipment and passing of risk to the customer and when estimates of are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations.

Note: Bold print and italics added by me.
In addition, it takes Medifast up to “24 hours” to process an order. Afterwards, the company ships the product on “the next business day.” See quote from the company website below:
What is your shipping policy? All orders are processed within 24 hours and shipped the next business day. Allow five to seven business days for standard shipping, or three to four business days for expedited shipping (additional charge). V.I.P.

Membership orders of $225 or more (total after coupons and discounts) get FREE standard shipping anywhere in the U.S. Non-V.I.P. Membership orders of $275 or more (total after coupons and discounts) get half-price standard shipping anywhere in the U.S.
As a minimum, Medifast ships customer orders on the very "next business day" after such orders are processed. If a customer order takes, for example, 23 hours to process, the shipment of product can potentially occur two business days after the order is processed.

If a company processes an order from a customer prior to the end of a reporting period, but does not ship the product until after the end of the accounting period, in such instance, the company reports a "deferred revenue" liability (meaning the company owes the customer products that have not been delivered). Here is the accounting entry: Debit - Cash or Accounts Receivable (asset account) and Credit - Deferred Revenue (liability account).

However, Medifast's financial disclosures showed no deferred revenue liabilities in its 2009 10-K report for both 2009 and 2008 fiscal years. See selected disclosures below:

Wednesday, June 09, 2010

How White-Collar Criminals Exploit Your Vanity - Beware of Compliments

Artwork by Marta Dahlig
Last Friday, I was the key note speaker at the Oregon Health Care Fraud Working Group Training Seminar, sponsored by the United State Attorney's Office for the District of Oregon. I explained to the group that while emphasis on effective oversight and internal controls are important factors in preventing or deterring white-collar crime, not enough emphasis is given to the underlying psychology used by white-collar criminals to prey on their victims and effectively commit their crimes.

I have said many times that, "White-collar criminals consider your humanity as a weakness to be exploited in the execution of their crimes" and as the cold-blooded and ruthless criminal CFO of Crazy Eddie, I learned that you can steal far more with a smile than you can with a gun.

White-collar criminals use a combination of charm and deceit to achieve their objectives. The more likable and charming that I was as a criminal, the easier it was for me to successfully lie to my victims and deceive them. People are far less skeptical of people who they like and the white-collar criminals know it and exploit it.

Rabbi Dr. Abraham Joshua Twerski, author of several books and a psychiatrist specializing in substance-abuse, once said:
Self-esteem is based on the realization of one's capacities, of what can do. Vanity is the feeling that admiration and exaltation should be expressed for what one has done" 
Self-esteem is a positive character trait and unfortunately vanity helps build self-confidence and self-esteem. As a criminal, I took advantage of the vanity of my victims to make myself more likable to them, increase the likelihood that they would believe my lies. After all, who does not like a nice compliment, now and then?

For example, please watch the final scene of the movie "The Devil's Advocate," where Lucifer, played by Al Pacino, convinces attorney Kevin Lomax, played by Keanu Reeves, to do an exclusive newspaper story and afterwards, proudly exclaims "Vanity, definitely my favorite, sin." Link here.




Like Lucifer, vanity is the favorite sin of the white-collar criminal and vanity is part of everyone's humanity.

My friend Ilene Carrie (syndicated blogger, editor at Phil's Stock World, and attorney) attended the Oregon Health Care Fraud Working Group Training Seminar and interviewed me. Her article can be read here.

After attending the lecture and having dinner together, she wonders:
As the prisoner in The Lady and The Tiger conundrum, I’m left wondering whether Sam’s telling the truth, and he’s still a criminal, or lying and is really on the path to redemption.
I am sorry Ilene, but Antar does not give closure.

To the rest of you, beware of smiles and compliments. You never know the true intentions behind any person's charm.

I will never be able to get a date with anyone again, after this blog post!

Written by:

Sam E. Antar

Special thanks to the United State Attorney's Office for the District of Oregon, Tricia Leishman (Department of Justice) and Toni Slocum Regence (BlueCross Blue Shield). I donated my services and paid all travel, lodging etc. out of pocket as an accommodation to the Department of Justice.

Recommended Reading from my Blog:

12/28/08: A New Year’s Message from a Convicted Felon: While you hope, criminals prey

12/25/06: The Art of Spinning: How to Identify Possible White Collar Criminals or at Least Unethical and Deceitful People Who You Should Avoid

Recommended Art:

Marta Dahlig - All Genre Gallery

Marta Dahlig's blog

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 investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not own Overstock.com securities long or short. My exposure of financial reporting violations by Overstock.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.