Friday, December 28, 2012

What Indicted SAC Capital Portfolio Manager Mathew Martoma Can Learn from Crazy Eddie

Back in March 1989, I faced an agonizing decision: Either cooperate with the F.B.I. and S.E.C. investigations of fraud at Crazy Eddie or spend a long time in prison behind bars. Likewise, former SAC Capital Advisors portfolio manager Mathew Martoma faces a similar important decision: Either cooperate with federal investigations of alleged illegal insider trading at SAC Capital or risk a long prison term. At the time I made my decision, I was married with three young children. Martoma is married with three young children too. We both had larger than life bosses who pressured us with unreasonable demands (me: my cousin Eddie Antar, Martoma: Steven A. Cohen).

Mathew Martoma and his wife after indictment
Facing an imminent indictment and a long prison term behind bars, I chose to cooperate with government investigators and turn in my cousin Eddie Antar and other relatives who ran our 18 year old criminal enterprise. Today, Mathew Martoma faces the same pressure I experienced back in 1989.

Apparently, federal investigators believe that Mathew Martoma is guilty of participating in an illegal insider trading scheme and can implicate his former boss, Steven Cohen as the driving force behind the alleged crime. According to the Wall Street Journal:

As federal agents pressed Mathew Martoma late last year to turn against his former boss, hedge-fund billionaire Steven A. Cohen, he fainted in the front yard of his Florida home.
"It was an upsetting experience," Charles Stillman, Mr. Martoma's lawyer, when asked about the incident. [Emphasis added.]

On December 21, 2012, Mathew Martoma was indicted for allegedly using information to illegally help SAC Capital profit from trades in certain publicly traded companies. According to the New York Times:

A federal grand jury in Manhattan indicted the former portfolio manager, Mathew Martoma, a month after the government arrested him on charges that he used inside tips about a clinical drug trial to help SAC earn profits and avoid losses. Prosecutors said the total benefit to SAC was $276 million.
SAC, based in Stamford, Conn., has been touched by several insider trading cases in recent years, but there is heightened attention surrounding the Martoma prosecution. For the first time, the government has tied questionable trades to Steven A. Cohen, the billionaire owner of SAC. [Emphasis added.]

Steven Cohen
My crimes were far worse than those alleged in the indictment against Martoma. I helped mastermind a scheme that defrauded investors and creditors of over $500 million and my crimes left over 3,000 people unemployed.

So far, Mathew Martoma maintains his innocence and has turned down cooperating with federal investigators. Martoma faces arraignment on January 3, 2013. His chances at beating the rap are slim. Over 90% of federal indictments result either in a trial conviction or guilty plea by the Defendant. Manhattan U.S. Attorney Preet Bharara has a perfect record tallying over seventy convictions with no acquittals in the massive ongoing federal insider trading probe.

If Mathew Martoma is in fact guilty as the indictment alleges and if he can implicate his former boss Steven Cohen, then time is running out for him to make a decision to cooperate with federal investigators. Potentially, if someone else comes forward and implicates Cohen before Martoma, he risks losing his best chance at avoiding a long prison term, because his value as a key witness would be diminished.

According to Fox Business, Mathew Martoma’s attorneys are charging over $1,000 per hour for legal fees and his former employer is footing the bill. That fact may provide a powerful incentive for Martoma not to cooperate with federal investigators. Likewise, for two years after being ousted from Crazy Eddie, my former boss Eddie Antar funded much of my legal fees as I was battling federal investigators. Finally, in 1989, I hired new attorneys who were not paid by my former employer and decided to cooperate with federal investigators.

My new lawyers, Anthony R. Mautone and Jonathan D. Warner advised me to come clean with the feds. I learned from them that quick timing and valuable information was the key to my future freedom. They told me that my duty to my wife and three children was more important than my loyalty to my cousin Eddie Antar and his immediate family.

Ultimately, the information that I provided federal investigators helped me avoid prison. I pleaded guilty to three felonies which carried a potential fifteen year prison sentence. Despite a much more lenient jail sentence recommended by former United States Attorney Michael Chertoff, Judge Nicholas H. Politan went even further and sentenced me to only six months of house arrest. In addition, Politan sentenced me to 1,200 hours of community service and I paid nominal fines and penalties totaling only $30,000. In my settlement with the victims of my crimes, I avoided all civil liability. I was able to avoid harsh punishment due to my extensive cooperation with federal investigators and lawyers representing victims of my crimes.

If the allegations in the indictment are true, Mathew Martoma’s only value to federal investigators is the potential information he can provide them about suspected illegal activities by his former boss Steven Cohen and others. Mathew Martoma has a lot of thinking to do and he’d better do it fast, because timing is running out. If he's convicted of the crimes alleged in his indictment, he faces up to twenty years in prison and I doubt that the feds will show him any mercy and give him any leniency.

Written by:

Sam E. Antar

Photo credits

NY Post: Mathew Martoma with his wife after indictment

Marketfolly: Steven Cohen

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

Tuesday, November 13, 2012

Judge Orders Overstock.com to Produce Evidence in California Consumer Fraud Lawsuit, While Major Investor Unloads Shares

A new development recently emerged in the consumer fraud lawsuit that seven California district attorneys have filed against Overstock.com (NASDAQ: OSTK) which raises a significant question for Overstock shareholders: What is the company trying to hide?

For the second time in the last two years, Overstock.com has “refused” to turn over crucial information about potential witnesses to the prosecutors, according to recent court filings. Judge Wynne Carvill had to issue a court order compelling Overstock.com to turn over such information, as Judge Robert B. Freeman had done in a previous court ruling.

The District Attorneys are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from Overstock.com. Evidently Overstock feels that the information it has withheld, which it must now disclose, will help the DAs in achieving that goal.

Judge compels Overstock.com to produce documents

In the lawsuit, filed in November 2010, the California DAs alleged that “Overstock routinely and systematically made untrue and misleading comparative advertising claims about the prices of its products.” On April 1, 2011, the District Attorney of Alameda County filed a motion to compel Overstock.com to turn over contact information for certain former employees with knowledge of alleged fraudulent pricing practices because the company “refused” to turn over such information. On May 17, 2011, Judge Robert B. Freeman issued a court order to compel Overstock.com to turn over the information to the district attorneys.

More recently, on October 19, 2012, the District Attorneys again had to go to court to deal with Overstock's stubborn refusal to share potentially damaging information with the prosecutors. They complained that:

The issue now facing the court is virtually identical to the one it was forced to decide last year. The consumers who complained to Overstock - like Overstock's former employees - are potential witnesses to the deceptiveness of its comparison pricing practices. These individuals likely have first-hand knowledge of specific instances when Overstock's comparison prices were misleading or simply incorrect, as well as the methods used by Overstock to redress these: errors. This information is relevant and material to prove disputed facts of consequence to the determination of this action and, at the very least, is calculated to lead to other admissible evidence. This Court should (again) compel Overstock to supply the requested information.

Patrick Byrne
On November 4, 2012, Judge Wynne Carvill ruled against Overstock. The judge said in his decision that Overstock would have to turn over the information the DAs want:

Defendant shall produce the personal identifying information of those of its customers who complained to Defendant or questioned Defendant or made a statement to Defendant about any of the comparison prices for any of Defendant's products during the applicable time period.

Overstock.com had argued that turning over customer information would violate its privacy policy, but Judge Carvill rejected their claim noting that:

As to Defendant's Privacy Policy, as correctly pointed out by Plaintiff, said policy specifically indicates that disclosure of personal identifiable information may happen to "comply with ... court orders.

Overstock.com had no issue violating the privacy of whistleblowers, journalists, and critics

Judd Bagley
Overstock.com's feigned concern for customer privacy is ironic. The company had no issue violating the privacy of whistleblowers, journalists, bloggers and critics in its pretexting and smear campaign of recent years, which have been amply documented in the media and this blog. Overstock and its surrogates, such as its former public relations spokesman Judd Bagley, have even waged war against their spouses families - their minor children included.

In February 2009, I identified certain violations of Generally Accepted Accounting Principles (GAAP) by Overstock.com that allowed it to fabricate a Q4 2008 profit rather than properly report a loss in that quarter. I urged the company to restate its financial reports to correct its improper accounting practices. CEO Patrick Byrne retaliated by personally attacking me on a stock market chat board, during various earnings calls, and in the press in an effort to discredit me. Instead of properly complying with GAAP, Overstock.com continued to overstate income in Q1, Q2, and Q3 2009.

Byrne's hired thug Bagley even injected himself into my divorce proceedings, contacting my former spouse, as well as using illegal pretexting tactics to "friend" my children and relatives on Facebook using a phony account. This was clear retaliation for my pointing out the company's accounting violations.

According to journalist and author Gary Weiss who uncovered the pretexting:

Bagley created "Larry Bergman" and an unknown number of phony Facebook accounts to con people into "friending" him. That way he could circumvent Facebook security, violating their rules and, well, Lord knows how many laws he broke in this pretexting scheme.

Attorney and Big Picture blogger (over 1.5 million monthly readers) Barry Rithholtz called Judd Bagley a "possible pedarast" after learning that he and his family members were pretexted. Eventually, Facebook (NASDAQ: FB) booted Bagley for violating its rules. It deleted both his false "Larry Bergman" profile and his personal profile.

Judd Bagley claimed that Overstock's internet pretexting scheme was designed to unveil connections between hedge funds and the journalists who write about them. However, Bagley targeted only journalists and bloggers (and their friends and family members thereof) who had written about Overstock. Altogether he compiled a database containing personal information on over 7,400 people.

In September 2009, the Securities and Exchange Commission started an investigation of Overstock.com’s accounting practices. In March 2010, Overstock.com finally admitted that it violated GAAP and restated its financial reports to correct its accounting violations, as I had recommended over a year earlier.

No consequences for retaliation and Judd Bagley is still in business

Unfortunately, the S.E.C. took no action against Overstock.com for retaliating against me as a whistleblower and other critics. The same can be said for Facebook. Although Judd Bagley was booted from Facebook, he’s back with new personal profile.

To add insult to injury, Overstock.com and Bagley have developed a new social media app for Facebook and Twitter called “myCurrent Desktop” which will collect personal information on its users. The app's terms of service explicitly states that there is "...no guarantee of confidentiality or privacy...." I have no doubt that some of that personal information could someday be used by Byrne and Bagley to stalk potential critics in the future.

Major Overstock.com shareholder starts dumping stock

S.E.C. filings reveal that right after the California District Attorneys complained about Overstock.com's refusal to turn over crucial information about customer complaints on October 19, 2012, money manager Francis Chou slowly started unloading his huge position in Overstock.com shares. Various funds managed by Chou had accumulated 3,260,738 shares of Overstock.com, about 13.9% of its outstanding shares. Since that date, Chou has sold 74,598 shares of Overstock.com. See the chart below:




In addition, Francis Chou has sold a number of call options. The purchaser(s) of those call options paid Chou a premium (fee) in return for the right to acquire a specified amount of Overstock.com shares at a certain price per share (strike price) on or before the expiration date. Chou makes a profit on those call option contracts if the value of Overstock.com’s shares do not rise above a certain price level (strike price plus premium) by the expiration date. In other words, if Overstock.com's stock price does not rise above the strike price and premium per share paid to Chou, they are worthless to the purchaser of the call options, and Chou makes a tidy profit. See the chart below:




In S.E.C. filings, Francis Chou claimed that he was selling Overstock.com shares for “diversification purposes” while at the same time he also claimed that such shares were “undervalued and represents an attractive investment opportunity.” However, he started selling his shares only after the District Attorneys complained to the Court that Overstock.com was refusing to turn over evidence about customer complaints. Furthermore, if Chou thinks Overstock.com shares are undervalued, why did he sell those call options?

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

Thursday, September 27, 2012

Green Mountain Coffee Roasters’ Growing Inventory Levels: Is It a Fumble or a Fraud?

Has Green Mountain Coffee Roasters (NASDAQ: GMCR) fumbled in managing its inventory or has it engaged in an inventory fraud to inflate earnings?

Background


As the criminal CFO of Crazy Eddie, I learned that the overstatement of inventory levels was the easiest way to inflate earnings. Auditors don't always supervise the counting of each and every physical inventory item to confirm their existence. Even if the auditors confirm the physical existence of all inventory items, they don't always trace how every single item arrived in a company's storage facilities. Therefore, the same inventory items can be moved from location to location and counted several times to inflate earnings.

In September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee's revenue accounting practices. Shortly afterwards, a class action lawsuit was filed against the company alleging that it engaged in securities fraud by inflating its inventory numbers to overstate its reported earnings. According to the amended class action lawsuit, several confidential witnesses who worked for Green Mountain Coffee allege that it moved around its inventory from location to location without a document trail to overstate inventory counts and inflate earnings. For example, paragraph 79 of the amended complaint alleges that:

CW7 [confidential witness 7], a lower-level employee in the Company's shipping department in Knoxville Tennessee, who worked at the Company from August 2009 through August 2011, also witnessed GMCR improperly transferring product from one plant to the next for no apparent reason. [Bracketed information added for clarity.]

In October 2011, money manager David Einhorn slammed Green Mountain Coffee's and noted "odd material movements" of inventory to possibly confound its auditors.

If there is inventory growth that is higher than revenue growth over extended periods of time combined with declining inventory turnover trends, it is considered to be a red flag for the possible inflation of inventory numbers and overstatement of earnings. For example, before the Crazy Eddie fraud was uncovered, independent analyst Thornton L. O’glove noted that its inventory levels were growing much faster than revenues. He was suspicious that Crazy Eddie was fraudulently inflating its inventories to overstate its profits. Unfortunately, most investors and analysts ignored the red flags that he spotted. (Source: Wall Street Journal – By the Numbers: How One Analyst Scores Big by Finding the Dark Side, by Jeffrey A. Tannenbaum and Lee Berton, August 4, 1987).

Is Green Mountain Coffee another Crazy Eddie?

Green Mountain Coffee's inventory levels have grown much faster than its growth in revenues in the last seven quarters since the S.E.C started its probe. Therefore, Green Mountain Coffee's inventory turnover rate declined in each quarter reflecting longer periods of time to sell its products. A comparison of Green Mountain Coffee's financial reports reveal that ever larger amounts inventory on hand are required to sell relatively less products quarter-after-quarter and year-after-year. See the chart below comparing Green Mountain Coffee's reported revenue increases compared to its reported increases in inventories. (Click on the table image below to enlarge it.)


Likewise, Crazy Eddie's had a similar pattern of inventory increases that exceeded revenue increases over an extended period of time resulting in declining inventory turnover. It seemed like Crazy Eddie needed ever larger amounts of inventory to sell relatively less product. For example, in fiscal year 1987 Crazy Eddie's reported revenues increased 34% while its inventories increased 82% when compared to the previous fiscal year. Its reported inventories grew at more than twice the rate of reported revenues. In November 1987, new management ousted the Antar's from Crazy Eddie and discovered that most of the inventory on its books did not exist!

Similarly, Green Mountain Coffee's reported inventories grew at more than twice the rate of revenues in the last two quarters. In the most recent quarter ended June 23, 2012, its reported revenues grew 21% while its inventories grew 60% when compared to the previous fiscal year's comparable quarter. In the quarter ended March 24, 2012, Green Mountain Coffee's reported revenues grew 37% while its reported inventories grew 100% when compared to the previous fiscal year's comparable quarter.

Consistent decline in inventory turnover

In each the last seven quarters, Green Mountain Coffee's inventory turnover has decreased when each quarter’s numbers are compared to the same quarter of the previous fiscal year. For example, in the latest quarter ended June 23, 2012, it took Green Mountain Coffee an average of 102.04 days to sell its inventory compared to 72.12 days in the same quarter of the previous fiscal year. In the quarter ended June 26, 2010 it took Green Mountain Coffee an average of only 64.89 days to sell its inventory. (Click on table images below to enlarge them.)


Green Mountain Coffee has claimed that it stocked up on inventories in each quarter in order to meet anticipated customer demand. However, in each of the last seven quarters, Green Mountain Coffee's rate of inventory buildup exceeded its own estimates of anticipated revenues. When it beat its own revenue projections, its inventory turns should have increased because it ended the period with fewer inventories on hand than it had anticipated. However, Green Mountain Coffee's inventory turnover still decreased in those periods.

When Green Mountain Coffee failed to meet its revenue projections, inventory turnover understandably decreased because it had more inventory on hand than it had anticipated. However, even if it had made up for the shortfall in sales by selling more products and depleting more inventory to match its revenue projections, its inventory turnover rate still would have decreased. Therefore, Green Mountain Coffee's consistent decline in inventory turnover rates cannot be explained by its failure to meet revenue projections. In any case, its inventory buildup appears to defy rational explanation.

Inventory turnover declined even when Green Mountain Coffee beat minimum and maximum revenue expectations

In four of the last seven quarters, Green Mountain Coffee's reported revenues exceeded both the minimum and maximum guidance it gave to investors several weeks before the close of the quarter (see green highlighted areas in the table above). Inventory turnover should have been higher because the company pushed its product out the door faster to meet unexpected excessive demand from its customers. However, Green Mountain Coffee’s inventory turnover decreased, reflecting a longer time to sell its inventory despite reporting revenues that exceeded its minimum and maximum projections.

When Green Mountain Coffees sales fell below expectations, inventory turns would have still declined if it had met expectations

In two of the last seven quarters, Green Mountain Coffee failed to meet both its minimum and maximum revenue projections it gave investors just a few weeks before the end of each quarter. Therefore, a decline in inventory turns would be expected because it sold fewer products than it anticipated to its customers and had more inventory on hand than it anticipated at the end of the period. However, even if the company had matched its revenue projections by selling more merchandise, its inventory turnover would have still declined in those same quarters. The decline in inventory turnover cannot be explained by a failure to meet revenue expectations, (See red highlighted areas in the tables above and below).

For example, in the quarter ended March 24, 2012 Green Mountain Coffee’s reported revenues of $885.052 million were $54.052 million short of its minimum revenue expectation and $86.435 million short of its maximum revenue expectations. Green Mountain Coffee reported a gross profit on revenues of 35.37% in that quarter. Therefore, the cost of product that it sold to customers was 64.63% of revenues.

To meet its minimum revenue projection, Green Mountain Coffee needed to sell an additional $54.052 million of products costing it approximately $34.934 million ($54.052 million multiplied by 64.63%). To meet its maximum revenue projection, Green Mountain Coffee needed to sell an additional $86.435 million of products costing it approximately $55.863 million ($86.435 million multiplied by 64.63%).

Even if Green Mountain Coffee had achieved its minimum revenue estimate for the quarter ended March 24, 2012, it would have still taken the company 88.0 days to sell its inventory compared to only 64.06 days in the previous fiscal year. If Green Mountain Coffee had met its maximum revenue estimate for that quarter, it would have still taken the company 83.55 days to sell its inventory compared to only 64.06 days in the previous fiscal year. (Click on the table image below to enlarge it.)


Latest quarter

In the latest quarter ended June 23, 2012, Green Mountain Coffee’s reported revenues exceeded its minimum revenue guidance, but fell short of its maximum revenue guidance. It took an average of 102.04 days to sell its inventory compared to only 72.12 days in the same third quarter of the previous fiscal year. Its revenues increased 21% while its inventory levels increased by 60%. The company had projected a revenue increase of 20% to 25% for the quarter. Even if it had met its maximum 25% increase in revenue projection, it still would have taken an average of 97.55 days to sell its inventory compared to 72.12 days in the previous fiscal year. See the yellow highlighted areas in the tables above and below:


During a conference call with investors, Green Mountain Coffee CFO Fran Rathke attempted to deflect criticism over inventory levels by explaining that it was stocking up on brewers far in advance of the holiday season:

Because of the time it takes to ship brewers to the US from our contract manufacturers in Asia, we must have on hand all of the brewers we expect to sell during holidays by early October to ensure availability on retailer shelves. It is this timing dynamic that necessitates that we begin building brewer inventory starting in Q3 toward anticipated demand.

Green Mountain Coffee reported that total inventory at the end of the quarter had jumped 60% to $667.0 million compared to only $417.5 million in the previous year's comparable quarter. The brewer and accessory portion of the total inventory increased 73% to $301.5 million compared to $174.2 million in the previous year's comparable quarter. However, the balance of the total inventory excluding brewers and accessories grew still grew at 50% over the previous year. As I detailed above, revenues for the quarter only increased by 21% over the previous year's comparable quarter. Brewer and accessory sales increased only 32%, single serve pack sales increased only 31%, and other sales categories declined when compared to the previous fiscal year. Therefore, inventory turnover decreased in every revenue category.

Portfolio manager Ben Strubel took issue with Rathke and noted that the purported buildup in brewer inventories ahead of the holiday season was much higher than the buildup in the previous year taking into account anticipated revenue projections by the company.

On June 6, 2012, Green Mountain CEO Larry Blanford told investors at a Piper Jaffray Consumer Conference:

…But should something like that happen we have a number of tactical responses, one of which could in fact be deciding to raise the price of the K-Cup brewing system.

It appears that both Rathke and Blanford were fibbing to investors. On Tuesday September 26, 2012, Green Mountain Coffee announced that it was offering $50 rebates for its brewers. Investor Daniel Yu noted in his blog that:

GMCR is offering up to a $50 rebate in Keurig brewers, after saying they might raise prices just a few months ago. Should Larry Blanford, CEO of GMCR/Keurig, change his middle name to ‘liar’? Larry Liar Blanford?

Apparently, Green Mountain Coffee had too many brewers on hand ahead of the holiday season and must now cut prices to move them, contrary to previous comments by Rathke and Blanford. Fibbing by management aside, still the question remains as to whether Green Mountain Coffee also inflated its inventory numbers to create fictitious profits. Green Mountain Coffee's inventory buildup does not appear to be solely the result of mismanagement. Its unusual growth in reported inventory levels could be the result of intentional inflation to overstate earnings as alleged in the class action lawsuit.

Was it a fumble or fraud?

No matter how you slice and dice it, Green Mountain Coffee’s troubling growth in inventory levels is not a single quarter fluke. As evidenced by the consistent decline in inventory turnover over the last seven quarters, the company continues to build excessive layers of inventory on top of previous excessive layers of inventory.

The S.E.C. is investigating whether Green Mountain Coffee’s excessive growth in inventory levels resulted from mismanagement or a fraud. However, I caution them that claiming incompetence is the last refuge of the white-collar criminal. Fraudsters know that stupidity is not a crime.

Was it a fumble or fraud? Maybe it is both.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Green Mountain Coffee Roasters securities long or short.

Monday, September 10, 2012

Lawsuit Filed Against ZAGG Alleges It Concealed Stock Pledges

Last Thursday, a lawsuit seeking class action status was filed against ZAGG (NASDAQ: ZAGG) Incorporated, certain members of its board of directors, and certain officers of the company. It alleges that they violated federal securities laws by improperly concealing certain stock pledges made by ZAGG’s former CEO and Chairman Robert J. Pedersen. Other law firms who specialize in bringing class action lawsuits have announced that they are contemplating filing complaints against ZAGG. (Download the complaint here).

ZAGG makes protective coverings for Apple's (NASDAQ: AAPL) iPhone and iPad and other devices. Big-box retailers such as Best Buy (NYSE: BBY) and Walmart (NYSE: WMT) carry ZAGG's product.

Background

On Friday August 17, 2012 ZAGG issued a press release saying that its co-founder Robert Pedersen resigned from his posts as CEO and Chairman. It did not mention any reason for his resignation. Later that day, Robert Pedersen was interviewed by the Salt Lake Tribune and it reported that “Pedersen said he resigned in order to focus on his family, his church and a family foundation.” In addition, Pedersen filed a Form 4 report with the Securities and Exchange Commission. It disclosed that he sold about 515,000 shares at an average price of $8.2214 per share to “meet margin calls” on August 14, just three days before he resigned. Pedersen’s sale of stock to meet a margin call was not mentioned in either the ZAGG press release or interview with the Salt Lake Tribune.

On Monday, August 20, 2012, my blog asked “if the timing of his sale of stock had anything to do with his resignation.” In addition, I pointed out that on December 21, 2011, Pedersen sold 345,200 shares at an average price of $7.5248 per share "to meet an immediate financial obligation." His Form 4 filing did not mention any margin call even though a margin call is an immediate financial obligation. I suspected that Pedersen’s December 2011 sale of stock was also due to a margin call and asked for an explanation in my blog. Furthermore, I reported that a proxy report filed by ZAGG on April 27, 2012 did not mention any pledges of stock by Pedersen. Public companies are required to disclose stock pledges by insiders in proxy reports. Separately, I contacted the Securities and Exchange Commission and asked them to look into this matter.

On Tuesday August 28, 2012, ZAGG held a conference call with investors. ZAGG President and Interim CEO Randy Hales finally admitted that Pedersen’s resignation was related to his margin calls. In addition, Hales admitted that Pedersen had a margin call in December 2011 as I had suspected:

…departure was entirely related to the margin calls situation that started last December and unfortunately surfaced again two weeks ago.

On that same day, Robert Pedersen filed a Form 4 report disclosing that on August 24 he sold another 1,250,061 shares and received $8.626 million in gross proceeds to satisfy all of his remaining margin obligations. Despite the margin call issue that led to Pedersen's resignation, ZAGG plans to hire him for one year as an executive consultant.

After the conference call, I asked, "If Pedersen had stock pledges in December 2011 that were still outstanding in August 2012, why weren't they disclosed in ZAGG's April 2012 proxy report as required under S.E.C. rules?"

Class action lawsuit

Robert Pedersen
The class action lawsuit alleges that ZAGG, certain members of its Board of Directors, and certain officers knew that Pedersen had undisclosed stock pledges and margin calls going back to December 2011, but covered them up. According to the complaint:

3. Unbeknownst to the Company's shareholders, a "margin call situation" involving Robert G. Pedersen... began in December 2011, whereby Pedersen borrowed substantial amounts of monies, putting up his Zagg shares as collateral. Although Defendant Pedersen ultimately resigned his post as the Company's Chief Executive Officer ("CEO') due to the "margin call situation," investors were not informed that Defendant Pedersen had pledged his stock until after his resignation over eight months later.

4. On December 21, 2011, Defendant Pedersen sold nearly $2.6 million worth of Zagg stock. However, at that time, shareholders were only informed that Pedersen sold the stock to "meet an immediate financial obligation." In truth, the December 23 stock sale was made to meet a margin call. Moreover, further undisclosed to investors, Pedersen had more than a million additional shares posted as collateral, which were subject to margin calls. Realizing that Pederson had recklessly put his CEO position at risk at the expense of investors, the Company began a succession plan beginning in December 2011 to remove Pedersen as CEO, and to appoint Hales as his successor. This accession plan was purposely hid from investors.

Furthermore, the complaint alleges that the defendant’s violated federal securities law by not disclosing Pedersen's stock pledges in the April 27, 2012 proxy report (paragraph 6). In addition, it alleges that former CEO Robert Pedersen and current CFO Brandon O’Brien signed "materially false and/or misleading" Sarbanes-Oxley certifications (paragraph 34 to 40).

According to the Salt Lake Tribune:

Jeff Jones, attorney for Zagg, said Friday that "the claims are without any factual or legal basis, and the company will defend them very vigorously."

ZAGG will probably try to get the complaint dismissed. If the lawsuit survives a motion to dismiss, its officers and directors could face potentially embarrassing pre-trial deposition testimony. Defending a class action lawsuit can be a very costly affair. Even if ZAGG has a current directors and officers' liability insurance policy, it could face more costly coverage in the future. If such litigation moves forward, it could take up a lot of management's attention that could be better used to run the business. I personally believe that if ZAGG and Pedersen had been more transparent about the stock pledges early on, they could have saved themselves a lot of trouble.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness from my victims for my vicious crimes. My past sins are unforgivable.

I do not own any ZAGG securities long or short.

Real Estate Investor Who Fled Country Now Seeks to Raise $1 Billion in IPO

United Realty Trust Incorporated is seeking up to $1 billion of capital from investors in an initial public offering (IPO). Deep inside the prospectus on pages 89 and 90 is a startling disclosure about Eli Verschleiser, its President and member of its Board of Directors:

At the age of 17, while a high school student, Eli was subpoenaed to appear before a federal grand jury inquiring into the fraudulent activities of a group of individuals he knew. Eli exercised his Fifth Amendment rights and continued to do so after being given “use immunity.” Eli appeared before a federal judge who directed him to reappear. He did not reappear and, instead, moved overseas, where he remained for several years. While overseas, a federal indictment was unsealed naming over 20 individuals in connection with fraudulent activities, including Eli. Approximately two years later, his family contacted an attorney to help him return to the country. He eventually pleaded guilty to one count of failure to appear, a misdemeanor. He received one-year probation and 100 hours of community service as a sentence. The charges against him related to the fraudulent activities were dismissed.

The disclosure does not call Eli Verschleiser a fugitive. Did Verschleiser conveniently move overseas after being directed to “reappear” in front a federal judge? Where did he go? Who were the characters that he was involved with? Why did he wait over two years before returning to America? As of the time of this publication, his biography on the company's website makes no mention of the above incident.


Eli Verschleiser
A blind pool offering or a blind trust offering?

United Realty Trust’s effort to raise capital is known as a “blind pool offering” since it does not own any properties and has not yet identified any properties for investment. The "sponsor" of the offering is United Realty Advisor Holdings LLC. It is directly and indirectly controlled by Eli Verschleiser and Jacob Frydman. The sponsor indirectly controls United Realty Advisors LP which is the "advisor" and is responsible for managing day-to-day operations and identifying property for investment.

According to the prospectus, a couple of Frydman's entities went bust:

In February 2004, Mr. Frydman was chief executive officer of the general partner, and a 1% owner, of two entities which, while engaged in separate land development transactions, each filed petitions for relief under Chapter 11 of the United States Bankruptcy Code.

The prospectus cautions that:

We and our advisor have no operating history, we have no established financing sources, our sponsor has no experience operating a public REIT, and the performance of the prior real estate investment programs of the principals of our sponsor may not be indicative of our future results.

Furthermore, the prospectus warned that:

You may be more likely to sustain a loss on your investment because our sponsor does not have as strong an economic incentive to avoid losses as does a sponsor that has made significant equity investments in its company.

Instead of calling it a blind pool offering, maybe it should be called a blind trust offering?

Closing comment

Eli Verschleiser has "no experience operating a public REIT." He should understand that it is normal for him to be the subject of extra public scrutiny if he plans to take United Realty Trust Public. He shouldn’t hide behind nuanced language buried deep inside of a prospectus. The way that I learned to deal with my past transgressions is to be completely upfront about them. Hopefully, Verschleiser has learned from his youthful errors.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness from my victims for my vicious crimes. My past sins are unforgivable.

I no financial relationship with United Realty Trust Inc. or any of its affiliates.

Tuesday, August 28, 2012

ZAGG Conference Call Raises More Questions than Answers about Pedersen's Resignation

Updated

Late Tuesday afternoon August 28, 2012, ZAGG Inc. (NADAQ: ZAGG) held a conference call with investors in an effort explain the sudden resignation of its co-founder Robert Pedersen as its CEO and Chairman of the Board of Directors on August 17. However, the company's explanation of the reasons behind Pedersen's resignation raises more questions than it answers.

Background

On Friday August 17, 2012 Robert Pedersen resigned from his posts as CEO and Chairman of ZAGG. The company’s press release did not mention any reason for his resignation. However, on that very same day after the market closed Robert Pedersen filed a Form 4 with the Securities and Exchange Commission. It disclosed that he sold 515,000 shares at an average price of $8.2214 per share on August 14, just three days before ZAGG announced that he resigned from the company. Pedersen sold 512,240 of those shares to "to meet margin calls" and 2,760 shares were sold separately. He collected $4.234 million in gross proceeds from his sales of stock and it appears that most of that amount was used to satisfy his margin call.

ZAGG contradicts Pedersen's explanation of his resignation to Salt Lake Tribune

Originally, Pedersen told the Salt Lake Tribune that he resigned to spend more time with his family. He did not mention that his resignation was due to his selling stock three days earlier to meet a margin call:

Pedersen said he resigned in order to focus on his family, his church and a family foundation. But he also pointed to a 25 percent drop in the value of the company’s shares after its guidance for this year did not meet analyst’s expectations.
"Running a public company is different than running a private company," he said Friday evening in a telephone interview from Alaska where he was vacationing with family. "And running a $250 million company is different than running a company going from zero to $250 [million in annual revenue]."

Robert Pedersen
It turns out that Pedersen's resignation on August 17 was due to his sale of stock on August 14 to satisfy a margin call.

During the conference call, ZAGG President and Interim CEO Randy Hales appears to have contradicted Pederson’s reason for resigning that he had given to the Salt Lake Tribune, saying it related to his sale of stock to satisfy a margin call:

In connection with Robert Pedersen's recently reported sales of ZAGG's shares as a result of a margin call, the ZAGG board in counsel with Robert made a mutual decision concerning Robert's ongoing role at ZAGG ...this decision upheld the board's priority to protecting shareholder value.

Why didn't Pedersen tell the Salt Lake Tribune that his resignation was a result of the margin call? Despite Pedersen's apparent lack of transparency, ZAGG is keeping him on as an executive consultant.

On August 24, 2012, Pedersen sold another 1,250,061 shares and received $8.626 million in gross proceeds to satisfy all of his remaining margin obligations.

Did ZAGG's proxy report improperly omit disclosure of Pedersen's stock pledges?

During today's conference call, ZAGG President and Interim CEO Randy Hales said that Robert Pedersen's:

departure was entirely related to the margin calls situation that started last December and unfortunately surfaced again two weeks ago. [Emphasis added.]

Last week, this blog pointed out that:

Back on December 21, 2011, Pedersen sold 345,200 shares at an average price of $7.5248 per share and received proceeds totaling $2.598 million "to meet an immediate financial obligation." No mention was made of any stock pledges at that time. I'd love to know the reason behind that "immediate financial obligation."

At that time, I suspected that Pedersen’s sale of stock to purportedly meet an “immediate financial obligation” was actually a sale of stock to meet a margin call. Now, it appears that Pedersen’s December 2011 sale of stock was to meet a margin call too. Why didn't Pedersen specify that his December 2011 sale of stock resulted from a margin call? If ZAGG had known that Pedersen had a margin call in December 2011, why didn’t it call on Pedersen to resign last December instead of last week?

Furthermore, I noted that:

A proxy report filed by ZAGG on April 27, 2012 does not mention any pledges of stock by Pedersen. Public companies must disclose stock pledges by insiders in proxy reports.

If Pedersen had stock pledges in December 2011 that were still outstanding in August 2012, why weren’t they disclosed in ZAGG’s April 2012 proxy report as required under S.E.C. rules?

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any ZAGG securities long or short.

Monday, August 20, 2012

ZAGG CEO Sold Stock Three Days before His Resignation

Updated at 8:26 AM ET

On Friday, August 17, 2012, ZAGG Inc. (NASDAQ: ZAGG) surprised investors and announced that its co-founder Robert G. Pedersen II resigned from his posts as CEO and Chairman of the company. The press release did not mention any reason for his resignation. The announcement was made after the stock market closed.

However, on that very same day after the market closed Robert Pedersen filed a Form 4 with the Securities and Exchange Commission. It disclosed that he sold 515,000 shares at an average price of $8.2214 per share on August 14, just three days before ZAGG announced that he resigned from the company. Pedersen sold 512,240 of those shares to "to meet margin calls" and 2,760 shares were sold separately. He collected $4.234 million in gross proceeds from his sales of stock and it appears that most of that amount was used to satisfy margin calls.

Back on December 21, 2011, Pedersen sold 345,200 shares at an average price of $7.5248 per share and received proceeds totaling $2.598 million "to meet an immediate financial obligation." No mention was made of any stock pledges at that time. I'd love to know the reason behind that "immediate financial obligation."

A proxy report filed by ZAGG on April 27, 2012 does not mention any pledges of stock by Pedersen. Public companies must disclose stock pledges by insiders in proxy reports.

It would be interesting to know exactly when Pedersen pledged (margined) his shares as collateral for his margin loan and if the timing of his sale of stock had anything to do with his resignation. Furthermore, did Pedersen know that he was going to resign when he sold his shares on August 14?

Written by,

Sam E. Antar

Update

This morning, after this blog post was originally published, ZAGG filed an 8-K report with the Securities and Exchange Commission disclosing it adopted a new policy prohibiting certain insiders from engaging in certain transactions including pledging their shares:

Policy regarding holding Company securities in Executive and Directors margin accounts
On August 16, 2012, the Board of Directors of the Registrant adopted a policy (the “Policy”) relating to short-term or speculative transactions in the Registrant’s securities by directors, officers, and 10% holders of the Registrant’s securities. Specifically, the policy states that such individuals are prohibited from engaging in short-term or speculative transactions involving the Registrant’s securities, such as publicly traded options, short sales, puts, and calls, hedging transactions and holding the Registrant’s securities in a margin account.

ZAGG's policy against margin loans was purportedly adopted two days after Pedersen sold his shares to satisfy a margin call and one day before it announced his resignation. The 8-K report made no reference to Pedersen's sale of stock to satisfy a margin call or disclose a reason for his resignation.

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any ZAGG securities long or short.

Tuesday, July 24, 2012

Can Green Mountain Coffee Roasters explain those missing beans?

Green Mountain Coffee Roasters (NASDAQ: GMCR) can't seem to get its act together. It appears to have made a significant error in a recent revision of its segment numbers. Specifically, $15.2 million of purported revenue adjustments for a twenty-six period in 2011 are unaccounted for. Its revenue adjustments do not match revenue numbers disclosed in other financial reports.

Background

Green Mountain Coffee Roasters operates its business under three segments: Specialty Coffee business unit (“SCBU”), Keurig business unit (“KBU”) and a Canadian business unit (“CBU”). Starting in fiscal year 2012, GMCR moved its Timothy’s subsidiary out of the SCBU segment and into the CBU segment. At the same time it moved a portion of the At Home ("AH") single cup business from its KBU segment to its CBU segment.

In subsequent 10-Q reports issued during fiscal year 2012, Green Mountain Coffee revised its previous fiscal year 2011 segment numbers to show Timothy’s as part of the CBU segment. Likewise, it revised its fiscal year 2011 segment numbers to show the AH single cup business as part of the CBU segment. The company revised its previous fiscal year segment numbers to make them comparable on a year-to-year basis. Therefore, items such as revenues, expenses, income, assets and liabilities that had been previously included in the SCBU segment for Timothy’s and the KBU segment for the AH single cup business should have been included in the CBU segment numbers when it reported its revised fiscal year 2011 numbers.

Those revisions reveal discrepancies in Green Mountain Coffee’s segment numbers. Specifically, Timothy’s sales to unaffiliated customers (outside customers) that were subtracted from the SCBU segment and added to the CBU segment should have matched its contribution to consolidated revenues that were disclosed in previous financial reports. Those revenue numbers don’t match up. $15.2 million of those revenue adjustments are unaccounted for.

Green Mountain Coffee's revised segment numbers compared to originally reported segment numbers

In the 10-Q report (page 12) for the period ended March 24, 2012, Green Mountain Coffee described its revision of the previous fiscal year 2011 segment numbers:

Effective at the beginning of fiscal year 2012, the Company changed its organizational structure to align certain portions of its business by geography. Prior to fiscal 2012, sales and operations associated with the Timothy’s brand were included in the SCBU segment and a portion of the AH single cup business with retailers in Canada was included in the KBU segment. Under the new structure, Timothy’s and all of the AH single cup business with retailers in Canada are included in the CBU segment.

Furthermore, it disclosed:

The following tables summarize selected financial data for segment disclosures for the thirteen and twenty-six week periods ended March 24, 2012 and March 26, 2011. Selected financial data for segment disclosures for the thirteen and twenty-six weeks ended March 26, 2011 have been recast to reflect Timothy’s and the AH single cup business with retailers in Canada in the CBU segment. [Emphasis added.]

In that same March 24, 2012 10-Q report (page 14), Green Mountain Coffee presented the following revised segment revenue numbers for the previous fiscal year twenty-six weeks ended March 26, 2011. (Click on image to enlarge.)


Originally, Green Mountain Coffee had reported the following segment numbers in the previous fiscal year 2011 10-Q report (page 14) for the same twenty-six weeks ended March 26, 2011. (Click on image to enlarge.)


In the March 24, 2012 10-Q report, the SCBU segment’s sales to unaffiliated customers for the previous year's twenty-six week period ended March 26, 2011 was revised $42.424 million lower. The revision should have reflected the removal of Timothy’s sales to unaffiliated customers from the SCBU segment into the CBU segment. However, in the March 26, 2011 10-Q report (page 20) Green Mountain Coffee reported only $27.2 million of sales to unaffiliated customers for Timothy’s. (Click on image to enlarge.)


The "additional $27.2 million of revenue" were sales to unaffiliated customers because it "contributed" to consolidated revenues. Timothy's sold product to both unaffiliated customers (outside customers) and affiliated customers (units within Green Mountain Coffee). Its sales to unaffiliated customers are an addition to consolidated revenues. 

The company subtracted $42.4 million of Timothy’s sales to unaffiliated customers from the SCBU segment for the twenty-six weeks ended March 26, 2011 to reflect its removal from that segment even though it previously reported that such sales were only $27.2 million. How could Green Mountain Coffee remove $15.2 million in sales to unaffiliated customers from the SCBU segment that it did not have?

Back in September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee’s accounting practices. Afterwards, the company reported that it found material weaknesses in internal controls over financial reporting. It restated its financial reports from fiscal year 2006 to fiscal year 2010 to correct certain violations of Generally Accepted Accounting Principles (GAAP) that helped it overstate its reported earnings in previous fiscal years. In its most recent 10-K report (page 57), the company maintained that it has "effective internal controls over financial reporting." I doubt it.

Written by,

Sam E. Antar

Recommended reading

NACD Directorship - Freudian Thinking to Prevent Fraud by NACD Editors

Financial Executives International - Sam E. Antar, Jonathan Marks, Address Anti-Fraud Collaboration by Edith Orenstein

The LongShortTrader: Green Mountain Coffee Roasters' Profits: Overstated or Misunderstood

The LongShortTrader: GMCR Refuses to Explain Exactly How the LongShortTrader's Report is Flawed

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Green Mountain Coffee Roasters securities long or short. My ongoing investigation of Green Mountain Coffee Roasters documented in this blog is a freebie for the Securities and Exchange Commission. Hopefully, they will put in a good word for me on judgment day.

Thursday, July 12, 2012

Green Mountain Coffee’s Numbers Submitted to S.E.C. Examiners Don’t Add Up

Last April, the Securities and Exchange Commission Division of Corporation Finance sent Green Mountain Coffee Roasters (NASDAQ: GMCR) a comment letter requesting certain information about its segment reporting in its 10-K report for the fiscal year ended September 24, 2011. The S.E.C.’s comment letter and the company’s response were just made public this week.

Green Mountain Coffee has three operating segments: Specialty Coffee business unit (“SCBU”), Keurig business unit (“KBU”) and a Canadian business unit (“CBU”). The company provided certain financial information to the S.E.C. examiners relating to its Timothy’s subsidiary for the five quarter period ended September 24, 2011 when it was included in the SCBU reportable segment. However, Timothy’s numbers appear to be erroneous when compared to financial disclosures made by the company in other S.E.C. filings.


If Green Mountain Coffee’s numbers are to be believed, then its income before taxes for its Timothy’s subsidiary exceeded gross profits by $10.7 million in the five quarter period ended September 24, 2011 when it was included in the SCBU segment. That seems highly unlikely given the company’s accounting policies for allocating income and expenses among its reporting segments and consolidated numbers reported for non-operating items. Timothy's financial performance appears to be substantially overstated over that five quarter period. (See calculations.)


Back in September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee’s accounting practices. Afterwards, the company restated its financial reports from fiscal year 2006 to fiscal year 2010 to correct certain violations of Generally Accepted Accounting Principles (GAAP) helped it overstate its reported earnings in previous fiscal years. A class action lawsuit was filed against the company that cited information provided by over a dozen informants who allege that it manipulated earnings and committed securities fraud in fiscal year 2010 and prior years. In addition, the lawsuit cites ongoing violations of accounting rules exposed in this blog.

How income before taxes is computed

Income before taxes is computed by starting with revenues and deducting cost of goods sold to compute gross profits. Operating expenses are deducted from gross profits to compute operating income. Non-operating income is added to operating income to compute income before taxes. Non-operating losses and interest expense is deducted from operating income to compute income before taxes.

Timothy’s questionable numbers

Green Mountain Coffee disclosed on page 8 of its responses to certain questions by the S.E.C. that:

….The components of SCBU as of September 24, 2011 were Green Mountain Coffee Roasters and Timothy’s (which is located in Canada). Timothy’s was operated as a plant for the SCBU prior to the Company’s acquisition in December 2010 of LJVH Holdings Inc. (“Van Houtte”) (which is also located in Canada). Timothy’s is shown separately in the segment managers package because it was acquired by the Company in November 2009 and included in the SCBU segment until September 24, 2011, when it was transferred to the CBU.
For purposes of evaluating economic characteristics of a component of an operating segment, the following criteria for aggregating operating segments in ASC 280-10 should be used:



Green Mountain Coffee claimed that its Timothy’s subsidiary averaged a 33% gross margin in the five quarters ended September 24, 2011. During those five quarters, Timothy’s had $78.3 million of revenues and income before taxes of $36.7 million. If Timothy’s gross margins were 33% as claimed, its gross profits were only $26 million ($78.3 million multiplied by 33% gross margin). Therefore, its income before taxes was $10.7 million higher than its gross profits. (See calculations.)

Furthermore, Green Mountain Coffee made the following disclosure about certain expenses attributed to Timothy’s in its 10-K report page F-23 for the fiscal year ended September 24, 2011:


Amortizable intangible assets acquired include approximately $83.2 million for customer relationships with an estimated life of 16 years, approximately $8.9 million for the Timothy’s trade name with an estimated life of 11 years and approximately $6.2 million for supply agreements with an estimated life of 11 years. The weighted-average amortization period for these assets is 15.2 years and will be amortized on a straight-line basis over their respective useful lives.
The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $69.3 million. The acquisition provided the Company with a Canadian presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment. The goodwill recognized is not deductible for tax purposes.

Based on the above disclosure, Timothy’s incurred $8.2 million of amortization expense in the five quarter period ended September 24, 2011. Those costs were included in its operating expenses (See calculations.)

We need to deduct that $8.2 million of amortization expense, any other operating expenses such as administrative costs, and any non-operating income or losses incurred by Timothy's from its gross profits of $26 million to compute its income before taxes. For the purpose of illustration, let’s be conservative and assume that Timothy’s incurred no other operating costs during that five quarter period. That leaves us with at most $17.8 million of income before taxes, so far. However, Timothy’s income before taxes was reported at $36.7 million. Therefore, Timothy’s would require a minimum of $18.9 million of non-operating income to explain why its income before taxes exceeded its gross profits. However, Green Mountain Coffee does not appear to have $18.9 million of non-operating income to substantiate Timothy’s reported income before taxes numbers.

Non-operating income and expenses don't substantiate reported numbers

In the five quarter period ended September 24, 2011, there were only four non-operating items effecting income before taxes that were reported by Green Mountain Coffee: interest expense, loss on foreign currency, loss on financial instruments, and other income. The company did not attribute certain non-operating items such as interest expense and foreign exchange gains to its reportable segments and underlying subsidiaries. Therefore, they cannot be used in computing Timothy’s income before taxes. Green Mountain Coffee’s 10-K report for the fiscal year ended September 24, 2011 explains the allocation of costs among its segments:


Expenses not specifically related to the SCBU, KBU or CBU operating segments are recorded in the “Corporate” segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to the entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors. In addition, fiscal 2009 corporate expenses are offset by $17.0 million of proceeds received from a litigation settlement with Kraft. Corporate assets include primarily cash, short-term investments, deferred tax assets, income tax receivable, certain notes receivable eliminated in consolidation, deferred issuance costs and fixed assets.

The only other non-operating items that are potentially attributable to Timothy’s are other income and the loss on financial instruments. However, the inclusion of any of those items in Timothy’s financial results cannot explain why its income before taxes exceeds its gross profit by $10.7 million.

For the purpose of illustration, let’s assume that other income is fully attributable to Timothy’s. As I detailed above, Timothy’s had a gross profit of $26 million in the five quarter period ended September 24, 2011. The amortization expense totaling $8.2 million that was attributed to Timothy’s during that five quarter period should be deducted from gross profits to compute income before taxes. Consolidated other income was only $0.596 million during those five quarters. It would be added to gross profits to compute income before taxes. That leaves Timothy’s with income before taxes of $18.4 million compared to $36.7 million reported in its S.E.C filings, leaving an $18.3 million discrepancy.

The inclusion of the loss on financial instruments in Timothy's financial results would increase the discrepancy in its income before taxes numbers. It is a loss which further reduces the income before taxes calculation below the number reported in other S.E.C. filings. Green Mountain Coffee had a $6.245 million loss on financial instruments during the five quarter period ended September 24, 2011. If that amount is deducted Timothy’s gross margins to compute income before taxes, it would reduce Timothy’s income before taxes to only $12.2 million compared to $36.7 reported in various S.E.C. filings, leaving a $23.3 million unexplained discrepancy.


The non-operating income numbers reported by Green Mountain Coffee cannot substantiate Timothy’s reporting $10.7 million of income before taxes in excess of gross profits. Therefore, it appears that Timothy’s reported income before taxes in S.E.C. filings is substantially overstated and an erroneous number.

The only other way that Timothy’s income before taxes could have exceeded its gross profits was if its operating expenses were negative. Such a scenario could only be possible if there were undisclosed accounting errors from previous periods that were corrected in those five quarters by making offsetting adjustments (reversing positive operating expenses to negative). If that happened, then Green Mountain Coffee failed to make proper disclosures to investors about accounting errors.

Written by:

Sam E. Antar

Recommended Reading

Accounting Today - Crazy Eddie’s Cousin Sam Sees Greater Potential for Fraud by Michael Cohn

National Association of Corporate Directors (NACD Directorship) - Freudian Thinking to Prevent Fraud by NACD Editors

Financial Executives International Financial Reporting Blog - Fraud, Freud and Superheros by Edith Orenstein

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin 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 heroic 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. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Green Mountain Coffee Roasters securities long or short. My ongoing investigation of Green Mountain Coffee Roasters documented in this blog is a freebie for the Securities and Exchange Commission.