Tuesday, February 21, 2012

How Overstock.com Violated S.E.C Rules on Timely Disclosures and Delayed Reporting a Default on Bank Loan

Last Friday after the stock market closed, Overstock.com (NASDAQ: OSTK) filed an 8-K report and disclosed that it defaulted on its loan covenants with U.S. Bank. The loan default resulted from Overstock.com's failure to file timely reports with the Securities and Exchange Commission. The bank granted the company a waiver of default. However, a close examination of the company’s various S.E.C. filings reveals that Overstock.com committed another securities law violation. The company improperly delayed the disclosure of the loan default to investors for several more weeks until it could resolve the default issue with the bank. Even in the face of an ongoing S.E.C. investigation into previous financial shenanigans, Overstock.com continues to flout securities law right under the nose of regulators.

Since public companies have up to four business days to file an 8-K report, they often choose to disclose negative news on a Friday, after the stock market closes and especially before a three-day holiday weekend, in hopes that most investors won't notice it. Overstock.com could have filed its 8-K report as early as Thursday February 16 or on Tuesday or Wednesday of the following week. Clearly, the company was hoping to bury news of its loan default and securities law violations.


On March 21, 2011, Overstock.com filed a proxy statement and its shareholders were asked to vote at the annual meeting on how frequently the company should seek an “advisory vote” on the compensation of its executive officers. Shareholders were given a choice on whether the advisory vote should be held every year, two years, or three years. However, the vote was “not binding.” The Board of Directors could ultimately decide, "...to hold an advisory vote on executive compensation more or less frequently, as applicable, than the option approved by our stockholders." After the Board finally reaches its decision, the company is required to file an amended 8-K report within four business days.

At the annual meeting on May 4, 2011, shareholders approved an “advisory vote” every three years. The next day, it filed an 8-K report which disclosed the amount of votes in favor of the nonbinding proposal. Apparently, the management of Overstock.com could not add or subtract. On May 24, 2011, the company filed an amended 8-K report to fix the amount of votes casted, though it did not change the outcome of the vote.

Misleading 8-K report filed with the Securities and Exchange Commission

On Friday, January 6, 2012, Overstock.com filed another amended 8-K report and disclosed that its Board made a final decision about the frequency of advisory votes on its executive’s compensation:

Consistent with the stockholders’ advisory vote on this matter, Overstock intends to hold future stockholder advisory votes on executive compensation once every three years until the next required vote on the frequency of stockholder votes on executive compensation.

It turns out that the amended 8-K report filed on January 6, 2012 was filed late. It should have been filed on September 30, 2011. By failing to file that amended 8-K report on time, Overstock.com defaulted on its loan agreement with U.S. Bank. The company misled investors by failing to disclose that the amended 8-K report should have been filed earlier. In addition, the company improperly omitted information about the loan default which resulted from its failure to file a timely report with the S.E.C. Instead, Overstock.com continued to deceive investors by delaying disclosure of its loan default until February 17, 2012, a day after it resolved its default issues with U.S. Bank.

On Friday, February 17, 2012, Overstock.com finally disclosed that it failed to file a timely 8-K report with the S.E.C. and informed investors that it defaulted on its loan with U.S. Bank. The lender granted the company a waiver of default:

….the Amendment grants a waiver of any default under the Financing Agreement resulting from the Company’s filing on January 6, 2012 of an amendment to its Form 8-K originally filed on May 5, 2011 to report that the Company would follow its own recommendation, as approved by the Company’s stockholders in an advisory vote on May 4, 2011, regarding the timing of future advisory votes of the Company’s stockholders regarding the Company’s executive compensation. The waiver is effective as of or immediately prior to the due date of the amendment to the Form 8-K. [Emphasis added.]

According to the amended loan document:

Pursuant to Section 12.1(d) of the Financing Agreement, an Event of Default shall occur if, among other things, Borrower fails to timely file with the Securities and Exchange Commission periodic and current reports that are in material compliance with the requirements of the Exchange Act. Borrower has informed Bank that Borrower failed to timely file a required amendment to Borrower’s Form 8-K regarding Borrower’s annual meeting of stockholders held on May 4, 2011 (such failure being referred to herein as the “Existing Default”). Borrower has requested that Bank waive the Existing Default, and subject to the full satisfaction of the conditions precedent set forth in Section 4.1 below, Bank hereby so waives the Existing Default, effective as of September 30, 2011. Except as expressly provided in the foregoing provisions of this Article II and as expressly provided in Article III below, all provisions of the Financing Agreement remain in full force and effect and the foregoing waiver will not apply to any other or subsequent failure to comply with the Section identified above or any other provision of the Financing Agreement. [Emphasis added.]

As I detailed above, Overstock.com's amended 8-K report filed on January 6, 2012 should have been filed on September 30, 2011. Therefore, U.S. Bank waived the “Existing Default” stemming from the company’s failure to file a timely amended 8-K report, “effective as of September 30, 2011.” The company misled investors by failing to disclose that the amended 8-K report was filed late. Furthermore, the amended 8-K report improperly omitted information that Overstock.com defaulted on its loan because it failed to file a timely report with the S.E.C. Under S.E.C. rules, an “event of default” is required to be disclosed within four business days (8-K General Instructions and Item 2.04). Therefore, the company improperly delayed disclosure of the loan default for several more weeks. On February 16, 2012, the company obtained a waiver from the bank. A day later it finally disclosed the loan default.

Weak financial position

Patrick Byrne, CEO
In the first nine months of 2011, Overstock.com reported a $16 million loss compared to only a $1.1 million loss during the previous year's nine month period. The company revealed it was "likely" that it would not comply with certain key terms of a Master Lease Agreement (sale-leaseback transaction) with U.S. Bank at December 31, 2011 (the end of the fourth quarter), unless "current trends improve substantially." Apparently, Overstock.com's soon to be reported fourth quarter numbers continued their downward trend. In late December 2011, Overstock.com was unable to restructure its Master Lease Agreement with U.S. Bank. It paid $20.329 million to U.S. Bank which included a $1.428 million prepayment penalty to avoid default and depleted the company of much needed working capital.

Overstock.com owes U.S. Bank $17 million under its current loan agreement and that amount is due on December 31, 2012. Therefore, the amount due U.S. Bank will be classified as a current liability on Overstock.com’s first quarter 2012 balance sheet and reduce its net working capital by another $17 million. The company had only $18.4 million in working capital as of September 30, 2011. It could report negative working capital on March 31, 2012 if current trends continue.

In December 9, 2011, Overstock.com filed a shelf registration statement with the Securities and Exchange Commission that would allow it to sell up to $200 million of its debt securities, common stock, warrants and other securities. It appears likely that Overstock.com will need to raise capital in the first quarter of 2012 to stay afloat. Such an offering will likely significantly dilute the value of existing common shares. (See "Overstock.com continued...." by the Davian Letter").

On December 14, 2011, the Overstock.com unloaded millions of dollars of excess inventory in a public auction and generated a mere $150,000 in cash, just pennies on the dollar. On January 30, 2012, held another public auction of excess merchandise, but the company did not disclose how much merchandise was sold.

Francis Chou takes a bath after CEO Patrick Byrne dumps shares

Francis Chou, F
Mutual funds managed by Canada-based investment manager Francis Chou have taken a bath on their investment in Overstock.com common shares. Chou’s funds have invested approximately $57 million in the company’s common stock and own approximately 14% of all its outstanding common shares. That investment is losing $34.9 million (down 61%) based on Friday’s closing stock price of $6.77 per share.

Overstock.com CEO Patrick Byrne is not as unfortunate as Francis Chou. Back on May 20 to May 24, 2010, Byrne's 100% controlled High Plains Investments LLC dumped 140,000 company shares at an average price of $22.11 per share and collected over $3 million in proceeds.

Ongoing S.E.C. investigation into fabricated earnings

Over the last several years, this blog has detailed various illegal accounting shenanigans used by Overstock.com to materially overstate its financial performance. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its pro forma earnings in violation of S.E.C. Regulation G. For example, in the quarter ended June 30, 2008 Overstock.com reported a positive $1.117 million EBITDA using an improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in the quarter ended December 31, 2008, the company improperly reported a $1.014 million profit by violating GAAP instead of a $0.705 million loss. In both cases I alerted the company by providing detailed information about its accounting irregularities. However, its CEO Patrick Byrne chose to vilify me rather than immediately correct its financial reports.

My accounting analysis was proven correct by Overstock.com's later revisions of financial reports. In September 2009, the Securities and Exchange Commission started an investigation of the company after I complained to the regulator. In March 2010, Overstock.com was forced to restate its financial reports to correct various GAAP violations initially identified in this blog. The S.E.C. investigation of Overstock.com is ongoing.

California District Attorneys allege consumer fraud

Overstock.com is being sued by District Attorneys from seven California District Attorneys who are alleging consumer fraud. They are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from the company for allegedly defrauding consumers. The Judge in that case had to compel an uncooperative Overstock.com to turn over information to the California District Attorneys.

Written by:

Sam E. Antar


Overstock - Another Default? by The Davian Letter

Recommended Reading

TheStreet.com: Facebook's Biggest Surprise -- No Funny Numbers by Gary Weiss

JOSB and the conflicting inventory accounting disclosures by The Davian Letter


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 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. My past sins are unforgivable.

I do not own any Overstock.com securities long or short and have no position in any of Francis Chou's funds.

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