It's now official: Overstock.com (NASDAQ: OSTK) defrauded consumers. Late Friday afternoon, a California Judge issued a tentative ruling in favor of district attorneys from eight California Counties who had sued Overstock.com for engaging in fraudulent comparative pricing practices. The Judge imposed a civil penalty in the amount of $6.819 million and approved issuance of an injunction to prevent Overstock.com from continuing its deceptive practices. To make matters worse, Overstock.com will have to reimburse the State of California possibly millions of dollars for legal fees, investigative costs, and other costs. [Download ruling.]
Overstock.com will definitely appeal the ruling, adding to its already huge legal costs, a huge lose-lose proposition for the company. For instance, last quarter the company reported a $2 million increase in legal fees resulting in large part from the "defense of a case brought by district attorneys in eight California counties."
Overstock.com refused to settle thinking it could get away with paying millions of dollars less in penalties
Back in March 2010, the California county district attorneys offered to resolve its investigation for $7.5 million, but Overstock.com's gun-toting CEO Patrick Byrne arrogantly refused to settle. According to Overstock.com's Q3 2010 10-Q report:
In March 2010, we received correspondence from the Office of the District Attorney of the County of Monterey in which the respective offices of the various district attorneys have made a collective proposal to resolve the dispute by our payment of $7.5 million in penalties and reimbursement. We disagree with the proposal and continue to discuss this matter with the authorities involved. In October 2010, we received notification that the Alameda County District Attorney joined the investigation group.
The company had accrued a loss contingency reserve totaling only $1.2 million to cover all its potential litigation risks, including but not limited to the district attorneys' investigation.
In response to an inquiry by the Securities and Exchange Commission, Overstock.com revealed that the loss contingency covered potential liabilities arising from the California investigation and an unrelated tax matter:
There are two matters for which we have established accrued liabilities, namely, the California district attorneys’ investigation and the administrative proceeding before the Ohio Tax Commissioner.
Evidently, Overstock.com thought it could get away with paying the State of California far less money than it was seeking in fines and restitution.
After the lawsuit was filed on November 17, 2010, Overstock.com attempted to obstruct efforts by the California District Attorneys to gather evidence of wrongdoing and was later compelled by the Judge to turn over crucial documentation. Overstock.com CEO Patrick Byrne claimed:
It is not our job to host DA’s on a no-limits fishing trip, especially when they have not acted in good faith in the past.
Now Overstock.com has been convicted of consumer fraud after spending several million dollars more in legal fees. In addition, it has to pay $6.819 million in fines plus possibly millions of dollars more in court costs.
Based on the ruling, it was Overstock.com who had not acted in good faith with District Attorneys investigating its wrongdoing and with consumers who were misled into believing that they were saving money by purchasing product from the company.
Lawsuit alleges fraud
On November 17, 2010, district attorneys from eight California counties filed a lawsuit against Overstock.com (NASDAQ: OSTK) alleging that it made up comparative prices:
20. ...Overstock does not always offer the lowest prices available online for the products it sells. In some cases, it charges significantly higher for those products than other merchants selling the identical products.
21. ...beginning at a date unknown to Plaintiff, but no later than January 1, 2006, Overstock has routinely and systematically made untrue and misleading comparative advertising claims about the prices which other merchants charge for the identical products offered by Overstock.
22. Often Overstock has not been determining or verifying the price other merchants charge for those identical products. Rather, Overstock has been using various misleading methods to make up its own “straw-man” prices which it claims other merchants are charging for those products, and then claiming that its own prices are significantly lower than those prices.
23. Overstock has advertised comparative prices which do not exist (i.e., simply making up the prices charged by other merchants).
24. When Overstock actually examined what merchants were charging for identical products, Overstock often deliberately chose the highest price charged for that product by any merchant instead of the price offered by most merchants for that product. These representations were likely to mislead consumers into believing that Overstock's prices were significantly lower than prices offered by other merchants.
25. For example, in 2007, Overstock.com sold a patio set on its site for $449.00. It claimed that the "List Price" for that patio was $999.99. The consumer who ordered the item noted that it came in a box with a Wal-Mart sticker showing the sales price to be $247.00. Wal-Mart was in fact offering the same patio set at $247.00 (and later, on clearance, as low as $218.00) on its web site. Overstock's "List Price" of $999.00 for the patio set was untrue and misleading.
After the lawsuit was filed, Chris Moran from the Consumerist remarked, "Apparently, the “O” in Overstock.com stands for “Overstating discounts and misleading customers,”....
Overstock.com defrauded consumers
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| Patrick Byrne, CEO |
18. ...Oh, I think it's been established that the 'List Price' is egregiously overstated. This place has some balls.
The Judge ruled that:
112. In sum, the court finds that Overstock has continuously used ARPs [advertised referenced price] in a manner designed to overstate the amount of savings to be enjoyed by shopping on the Overstock web site.
According to the tentative ruling, Overstock.com used phony formulas to set comparative prices or simply made up comparative prices:
114. Whenever Overstock used a formula to set an ARP [advertised referenced price] and then displayed a “You save” amount or percentage, it made a misleading statement as to the amount (and perhaps the existence) of a price reduction. When the ARP nomenclature was “list price,” the statement was also false for the same reason: the representation that there was a list price was false. In other words, where there was no actual list price but only one set by formula, the statement as to the dollar and percentage amount of the savings from the nonexistent list price was also false. When Overstock’s ARP was based on a “similar” product and then displayed a “You save” amount or percentage, the company made a misleading statement as to the amount (and perhaps the existence) of a price reduction. Whenever Overstock set an ARP based on the highest price it could find for the product, it made a misleading statement as to the amount (and perhaps the existence) of a price reduction. [Emphasis added.]
Injunction
Mindful that Overstock.com deliberately faked comparative prices, the Judge approved the issuance of the following injunction:
128. Overstock may not post any ARP [advertised referenced price] unless it verifies the reference price and documents that verification by a screen shot of the product offerings(s) and price(s) relied upon to comply with this order. The verification documentation shall be maintained for two years from the date the ad containing the ARP is initially posted, and the People may have reasonable access to such documentation throughout the five year period during which the injunction shall be in place.
The district attorneys from eight California counties will monitor Overstock.com's compliance with the injunctive order.
Written by:
Sam E. Antar
Additional reading
Gary Weiss: Overstock.com still scamming customers despite court ruling
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. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.
There is a saying, "It takes one to know one." I've provided professional work for the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify fraud and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. In addition, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. Recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud.
I do not own any Overstock.com securities long or short.
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