Were Groupon’s and Overstock’s Management and Auditors Stupid or Did They Condone Improper Accounting Practices?

Back on August 24, 2011, accounting professors J. Edward Ketz and Anthony H. Catanach Jr., reported in their blog that Groupon (planned ticker symbol: GRPN) violated Generally Accepted Accounting Principles (GAAP) in reporting its revenues and recommended that it restate its financial reports to correct its error. They sent a complaint to the Securities and Exchange Commission Whistleblower Office. Last week, Groupon restated its financial reports to comply with revenue accounting rules as called for by Ketz and Catanach. The company revised its reported 2009 revenues from $30.5 million to $14.5 million and its 2010 revenues from $713.4 million to $312.9 million – no small potatoes!

Why did Groupon’s CFO and its auditors at Ernst and Young (the third largest accounting firm in the world) miss revenue accounting violations? Ketz and Catanach did not have access to company management or its books and records. They found GAAP violations from merely reading financial reports filed with the S.E.C. in anticipation of the company’s initial public offering. They compared the company’s revenue accounting disclosures with applicable accounting rules and found material misstatements in violation of GAAP. Were Groupon’s management and its auditors stupid? Shouldn’t they know revenue accounting rules? In a blog post this evening, noted forensic accountant and author Tracy Coenen suggests that Groupon used higher and improper revenue numbers to mask troubling trends in its business model.

Over the last several years, my blog exposed a pattern of accounting shenanigans which helped Overstock.com (NASDAQ: OSTK) (also known as O.co) materially overstate its reported earnings. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its financial performance in violation of S.E.C. Regulation G. For example, in Q2 2008 Overstock.com reported a positive $1.117 million EBITDA using its improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, Overstock.com violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in Q4 2008, Overstock.com improperly reported a $1.014 million net profit instead of a $0.705 million net loss if it has followed GAAP.

In both cases, I provided the company with detailed information about its accounting irregularities, but its CEO Patrick Byrne chose to vilify me and continue violating accounting rules. In both cases, my analysis of Overstock.com's accounting violations was ultimately proven correct by its later revisions of financial reports. The S.E.C. is currently investigating Overstock.com for securities law violations.

Why was I was able to find accounting irregularities at Overstock.com missed by PricewaterhouseCoopers and Grant Thornton (the second and sixth largest accounting firms in the world)?  PricewaterhouseCoopers was Overstock.com's auditors from 1999 to 2008 and Grant Thornton was its auditors from Q1 to Q3 2009. Just like Professors Ketz and Catanach, I found accounting violations by merely reading Overstock.com's financial reports and comparing its financial disclosures to applicable accounting rules. I am not an accounting professor and I lost my CPA license because I am a convicted felon. Is a convicted felon and former CPA smarter than the company and two of the six largest public accounting firms?

Back in my Crazy Eddie days, in many cases I had to deceive my auditors at KPMG (then known as Peat Marwick Main) to manipulate earnings and defraud investors. In October 2000, Joseph T. Wells asked the following question about Crazy Eddie's auditors in the Journal of Accountancy:

Were the auditors stupid? No, just too trusting. After all, no one wants to think the client is a crook. But it happens all too often. That’s why the profession requires auditors to be skeptical.

I personally don’t believe that the managements of both Groupon and Overstock.com tricked their auditors into using improper accounting rules to misstate their respective company's financial performance. Further, I don’t believe that the managements and auditors of Groupon and Overstock.com were so stupid that they did not understand accounting rules. I believe that the managements of both companies simply chose to avoid following applicable accounting rules and their auditors condoned those practices. Seriously, can they be so stupid? If so, their audits are nothing but window dressing.

Public accounting firms are supposed to be gatekeepers and protect the integrity of financial reporting. However, financial reports have apparently become promotional materials to help inflate stock prices, rather than provide investors with a proper picture of a company’s financial performance. In too many cases, public accounting firms have become advocates of management at the expense of investors, creditors, and other users of financial information. Some investors don’t seem to care as long as they can profit from higher stock prices caused by improper accounting practices that are condoned management and so-called independent auditors.

Our government doesn’t seem to care, too. President Barack Obama wants cut red tape and make it easier for small companies to go public without going through a rigorous review process by the Securities and Exchange Commission. Front runner for the Republican Party presidential nomination Mitt Romney wants to repeal corporate governance and accounting reforms under the Sarbanes-Oxley Act altogether. Meanwhile, congressional Republicans have already succeeded in cutting funding for the Securities and Exchange Commission despite increased responsibilities under the Dodd-Frank Act.

Have you ever wondered why committing securities fraud is so easy and is going to get even easier in the future?

Written by:

Sam E. Antar

Recommended reading

TheStreet.com - Bucket List of Apologies -- SEC Edition by Gary Weiss

TheStreet.com - Obama Signals Green Light for Stock Fraud by Gary Weiss

Footnoted.com - The Footnoted Jobs Program... by Michelle Leder

Business Insider - "The Feds Are Drinking The Same Kool-Aid As Crazy Eddie's Former Auditors" by Sam E. Antar

Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum

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. In addition, I teach about white-collar crime for 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 have any position in Groupon or Overstock.com securities.

Why the SEC should not be duped by Overstock’s excuses to avoid sanctions

After almost two years of investigation by the Securities and Exchange Commission, Overstock.com (NASDAQ: OSTK), also known as O.co, faces a possible enforcement action and sanctions arising from certain accounting violations reported in this blog. The company cannot deny that it violated various accounting rules. My accounting analysis was proven correct by its later revisions of financial reports. To avoid an enforcement action and possible sanctions, the company has no choice but to attempt to persuade the SEC that it acted in good faith and its misstatements of financial reports were unintentional. That excuse is simply untrue in light of the company’s actions.

Over the last several years, I've reported on a pattern of accounting shenanigans which helped Overstock.com materially overstate its earnings. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its financial performance in violation of SEC Regulation G. From Q4 2008 to Q3 2009, it violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. In both cases, I provided the company with detailed information about its accounting irregularities, but its management chose to vilify me rather than immediately correct its financial reports. Even after Overstock.com revised its financial reporting, it still continued to smear me in retaliation for exposing accounting irregularities.

If the company and its auditors want to claim they acted in good faith, it follows that this convicted felon and former CPA has more knowledge about SEC reporting rules and GAAP than any of them. I guess that I must be an accounting genius. I was able to find accounting irregularities missed by PricewaterhouseCoopers and Grant Thornton (the third and sixth largest accounting firms in the world) who unlike me, had access to the company’s books and records. PricewaterhouseCoopers was Overstock.com's auditors from 1999 to 2008 and Grant Thornton was its auditors from Q1 to Q3 2009.

Further, the Sarbanes-Oxley Act of 2002 eliminates the excuse that a company relied on the erroneous advice of its auditors. It clearly places the primary responsibility for poor internal controls and improper financial reporting on management.

Overstock.com has so far restated its financial reports three times due to GAAP violations. Every single financial report from 1999 to Q3 2009 had to be revised from one to three times due to GAAP violations. Every single internal control certification signed by the CEO and CFO of the company during that period turned out to be false. Every single audit by PricewaterhouseCoopers from 1999 to 2008 and review by Grant Thornton in 2009 turned out to be flawed.

The Sarbanes-Oxley Act is a law to be enforced. Companies and their auditors who violate that Act must be held accountable by the SEC. Compliance is not a performance goal where violations are shrugged off by the SEC and where companies and their auditors who violate that Act are asked to do better next time. It's the law! The integrity of financial information is the main pillar underlying our capitalist economic system. It is not supposed to be the cat and mouse game that seems to be going on today between the SEC on one side and public companies and their auditors the other side.

Early lies about profitability

Patrick Byrne

On December 11, 2001, Patrick Byrne appeared on Fox News claimed, “We're profitable.” On March 5, 2002, Overstock.com filed an S-1 report in connection with its planned initial public offering. It contradicted Byrne’s claim that his company was anywhere near “profitable.” In future years, Byrne’s deceptive behavior continued as Overstock.com resorted to violating accounting rules to materially overstate its financial performance and even report profits when it was actually losing money.

Overstock.com violated SEC Regulation G governing non-GAAP pro forma numbers

In April 2004, Patrick Byrne appeared on the CNBC and said “I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook.” In 2007, Overstock.com changed its tune and starting using EBITDA in its financial reports. In February 2008, the company even said, “A multiple of EBITDA is currently the most standard measure of valuation in the industry.” With that admitted knowledge, the company used an improper EBITDA calculation to materially overstate its financial performance from Q2 2007 to Q2 2008.

On December 3, 2007, I detailed how Overstock.com improperly started its EBITDA calculation with operating income or loss (rather than net income or loss) and improperly added back stock-compensation costs. Under Regulation G, EBITDA can only be computed by starting from net income or net loss and adding back net interest (interest expense minus interest income), taxes, depreciation, and amortization. On May 28, 2008, I detailed how the SEC Division of Corporation Finance reviewed similar improper EBITDA calculations by two other public companies and made them comply with Regulation G. During this period, I sent multiple emails with links to my blog posts alerting the SEC and Overstock.com about the improper EBITDA calculations. However, the company defiantly continued to use an improper EBITDA calculation and materially overstated its financial performance. (See the chart below. Click on image to enlarge.)

In Q2 2008 (period ended 06/30/08), Overstock.com reported a positive $1.117 million EBITDA using its improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G.

During various conference calls, management made false comments in defense of its accounting policies and attacked me. On July 18, 2008, during the Q2 2008 earnings call, former CFO David Chidester falsely claimed that the company was justified in adding back stock compensation costs to compute EBITDA. He said “It’s completely the convention in our industry….” On October 24, 2008, during the Q3 2008 earnings call, Patrick Byrne falsely asserted that “The claim that EBITDA is not compliant with SEC definition, nonsense.” Byrne went on to call me, “Sam Antar the Crook.

Vindication

On November 7, 2008 Overstock.com filed its Q3 2008 10-Q and disclosed that it discovered errors in its accounting for customer refunds and credits. The company restated financial reports from Q1 2007 to Q2 2008 to correct those errors. In addition, it finally complied with SEC Regulation G and stopped calling its non-GAAP financial measure (operating income plus stock compensation) EBITDA. It warned investors that it was an “adjusted EBITDA” calculation.

On July 26 and September 12, 2010, I reported how seven other public companies used improper EBITDA calculations and violated SEC Regulation G. Unlike Overstock.com, those companies corrected their improper EBITDA calculations in their very next financial report and did not attack me for pointing it out.

Overstock.com violated GAAP


In February 4, 2009, I detailed how Overstock.com violated GAAP and materially overstated its earnings in Q4 2008. In that quarter, Overstock.com improperly reported a net profit instead of a net loss due to its GAAP violation. It was the company’s first reported net profit after 15 consecutive quarterly losses. I immediately notified the SEC and Overstock.com about its GAAP violations and urged the company to restate its financial reports to correct its illegal accounting practices. However, Overstock.com continued to violate GAAP and materially overstate its earnings from Q1 to Q3 2009.

Back in October 2008, Overstock.com discovered errors in accounting for customer refunds and credits. The company restated its financial reports from Q1 2007 to Q2 3008 and reduced its retained earnings by 8.2 million to correct those errors due to its overstatement of income during those periods. It also underbilled its fulfillment partners certain offsetting fees and reimbursements due the company arising from those errors. However, Overstock.com’s restatement of financial reports did not properly reflect adjustments for income that it already earned from those offsetting costs and reimbursements during those periods.

Public companies are required to use accrual basis accounting. Income is recognized in the period it is earned and not when it is later billed or when amounts are subsequently collected. Instead, the company recorded income as payments were received from its fulfillment partners on a non-GAAP cash basis in future accounting periods (Q4 2008 to Q3 2009). In other words, Overstock.com took income that should have been reported in prior reporting periods (Q2 2008 and before) and moved it to future reporting periods (Q4 2008 and later) to materially overstate its financial performance in those later reporting periods. The company effectively created a "cookie jar" reserve to inflate future earnings.

On February 6, 2009, Patrick Byrne responded to my initial accounting analysis with his usual vindictive attack on the InvestorVillage message board. He claimed that “Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.”

On February 23, 2009, Overstock.com filed its 2008 10-K report and claimed that a "gain contingency" existed to justify its accounting practices. It said that, “When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency.”

Judd Bagley

In April 2009, Patrick Byrne sent his paid hack Judd Bagley to spread false information my divorce, attempted to blackmail me into settling that case, and even tried to contact my ex-spouse in an attempt to intimidate me. At about the same time, Judd Bagley created a Facebook profile under the name of Larry Bergman and proceeded to con people into friending him. The company’s pretexting operation targeted me, journalists, bloggers, our families, and even minor children, too. Eventually, Facebook booted Bagley for violating its rules.

On July 22, 2009, during the Q2 2009 earnings call, Patrick Byrne called me “Sam Antar the Crook” because I dared to question his company’s claim that a "gain contingency" existed.

On August 5, 2009, I published a letter to the SEC that cited various accounting rules and pointed out that “No gain contingency existed.” Overstock.com had made the ridiculous assumption that all potential recoveries of underbilled fees and reimbursements owed to it from fulfillment partners (every single penny) were “not assured”. In addition, I noted that the company did not mention the existence of a “gain contingency” when it originally disclosed the underbilling error in its Q3 2008 10-Q report filed in November 2008. It waited until it filed its annual 2008 10-K report in February 2009 to claim that a gain contingency existed.

Further, I pointed out how Overstock.com used that same phony gain contingency rationale to further inflate its reported earnings in Q1 and Q2 2009. During 2009, the company found overbillings from vendors that occurred in 2008. When it corrected the 2008 overbillings from vendors in 2009, it inflated its reported income. It should have adjusted its 2008 financial reports to correct those errors.

SEC investigates

On September 17, 2009, the SEC Enforcement Division started investigating Overstock.com. On September 23, 2009, a Salt Lake Tribune article reported Patrick Byrne’s angry reaction with anti-Semitic overtones:

"Gary Weiss and Sam Antar are goniffs," Byrne declared, using a yiddish term that he says means "a con man, a hustler and a scoundrel." If the SEC is listening to them, their next step is to let Bernie Madoff write their indictment of me. 

Best-selling author and investigative reporter Gary Weiss had exposed Patrick Byrne’s dirty trick tactics against critics. Both Gary Weiss and I are Jewish.

In October 2009, Aaron Edelstein from Crain’s New York Business asked Patrick Byrne about my reporting of accounting irregularities. Byrne responded saying “He’s a criminal who works for short-sellers. He throws mud day after day. No matter what he says, he finds some spurious thing to jump up and down about.”

On October 1, 2009, the SEC Division of Corporation Finance started reviewing Overstock.com’s financial reports. It discovered that the company overpaid a fulfillment partner $785,000 during 2008. The company recovered that overpayment in Q1 2009 and improperly reported the overpayment recovery as income in that same quarter, rather than properly restate its 2008 financial reports to correct that error.  Grant Thornton, who replaced PricewaterhouseCoopers as Overstock.com’s auditors in 2009, claimed that it did not know about the 2008 overpayment and the Q1 2009 recovery from the fulfillment partner until October 2009. The SEC wanted Overstock.com to restate its financial reports to correct that error and other GAAP violations previously identified in my blog. Grant Thornton agreed.

The SEC reviewers also wanted to know why Overstock.com failed to report the existence of a gain contingency when it originally disclosed the underbilling error in its Q3 2008 10-Q report filed on November 7, 2008. The company waited until it filed its 2008 10-K report on February 23, 2009 to claim that a gain contingency existed. Overstock.com told them that as of November 2008 "...it would have been inappropriate to disclose a gain contingency." However, the 10-K report claimed that it determined that a gain contingency existed "When the underbilling was originally discovered...." back on October 24, 2008. If Overstock.com's 10-K disclosure was true, the company's explanation to the SEC could not be true. Likewise, if Overstock.com's explanation to the SEC was true, the company's 2008 10-K disclosure can't be true. Nevertheless, the SEC determined that no gain contingency existed, as I did my August letter.

On November 13, 2009, Overstock.com fired Grant Thornton rather than restate its financial reports. Three days later, Overstock.com defiantly issued an “unreviewed” Q3 2008 10-Q report without correcting its GAAP violations.

Jonathan Johnson

On November 18, 2009, Patrick Byrne falsely claimed that even if the company restated its financial reports, no previously reported profit would turn into a loss. Byrne said, “In fact, we as I understand it, this doesn't change any positive quarter to a negative quarter or any negative quarter to a positive quarter.

On November 24, 2009, the Salt Lake Tribune reported that Company President Jonathan Johnson said, “None of these changes that they [Grant Thornton] are talking about, or that people at the SEC are now asking about, make any of our quarters go from negative to positive or from positive to negative.”

Vindication

On December 29, 2009, Overstock.com hired KPMG to replace Grant Thornton. On January 29, 2010, Overstock.com warned investors that its financial reports “…. should no longer be relied upon.” On March 31, 2010, Overstock.com filed its 2009 10-K report and finally restated its financial reports to correct GAAP violations, as I recommended back in February 2009. The company also admitted that the "gain contingency…was an inappropriate accounting treatment.” (See the chart below detailing restatements. Click on image to enlarge.)

As it turns out, every comment made by Patrick Byrne and Jonathan Johnson were false. The company actually lost money in Q4 2008 rather than make a profit as previously claimed.

Back in February 2009, Byrne said “Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.” The "gibberish" was Overstock.com's illegal accounting practices and Byrne's ramblings in defense of his company's accounting shenanigans. I knew exactly what I was talking about.

Continued retaliation

In November 2010, District Attorneys from seven California counties filed a lawsuit alleging consumer fraud by Overstock.com. On April 12, 2011, I reported how the DAs complained to the court that Overstock.com was withholding personal contact information of former employees with possible knowledge of wrongdoing. That day, a Bloomberg reporter asked Patrick Byrne about the issue and he went on a disgusting rampage in his Deep Capture website:

The sounds of squealing could be heard over the low hum of the air recirculation machinery in the drab, windowless federal interview room.  “Please!” Sam Antar wimpered. “Let me write one more smear. Let me feel like I’m a player, one last time!”

The federal agent spoke sharply: “Silence!”  She turned to look at her colleagues with bemusement.  “Jesus, what is it with these finance gerbils? I haven’t seen someone break this pitifully since that bookkeeper in Reno. ” She set aside her Nutcracker Flail, took a long pull on her Gaulioses, and said, “OK, let’s give Sam the night off. We’ll get him cleaned up for the judge in the morning.”

With that, Sam Antar, still restrained in straightjacket, was hauled back to the Shower Room, where he spent the night toe-writing in excrement on the linoleum.

Which would be altogether unremarkable, were it not for the fact that within hours, a Bloomberg reporter named Clyde Eltzrothis called, asking me to comment on it.

Patrick Byrne went on to accuse the California District Attorneys of not acting in good faith:

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.

On May 18, 2011, Judge Robert B. Freeman granted the California District Attorney’s motion to compel Overstock.com to turn over the contact information of certain former employees. He rejected Byrne's argument.

Good faith?

Responsible companies that act in "good faith" fix their accounting errors and move on. They don't retaliate against whistleblowers who point out misstatements in financial reports. Patrick Byrne doesn't seem to be upset that Overstock.com violated accounting rules and had to restate its financial reports. Apparently, he's upset because his company's accounting irregularities were exposed. Byrne's disgusting prison fantasy involving me demonstrates his obsession to get back at me for pointing out his company's shenanigans. Byrne and his crew will make up anything and resort to any smear tactic in their attempts to punish me for uncovering their wrongdoing. But the fact remains that I uncovered violations of accounting rules which helped Overstock.com overstate its financial performance and the company made revisions in its financial reporting to correct those violations.

Final comments

Last year, the Dodd-Frank Act was signed into law and the SEC issued final regulations about whistleblower protections. On May 25, 2011, SEC Chairman Mary Schapiro said in a speech that, “… the final rules make clear that the statute’s whistleblower protections apply to anyone who provides us information, even if that information relates to a possible securities law violation, and regardless of whether it leads to a successful enforcement action.”

Here, the SEC has a whistleblower that correctly identified accounting violations which caused a public company to restate its financial reports. The SEC has clear evidence of blatant retaliation by the issuer against that whistleblower. The freedom to criticize accounting practices without fear of reprisal from public companies is essential to our democracy and the integrity of our capital markets. It’s time for the SEC to put its money where its mouth is. The ball is in their court!

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. In addition, I teach about white-collar crime for 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.

Will KPMG Ever Wake Up and Finally Learn Its Lesson after Being Duped into Completing Crazy Eddie’s Audits Too Early Twenty Three Years Ago?

Sometimes I wonder what it will take for major accounting firms like KPMG to finally wake up and learn the lesson of how criminal management teams dupe them into signing off on clean audit opinions before completing the field work, just as I did as the criminal CFO of Crazy Eddie back in the day.

KPMG cited by British authorities for prematurely signing off on audits

Recently, Adam Jones of the Financial Times reported that KPMG was “rapped for signing off on audits” before the completion of field work by the United Kingdom’s Financial Reporting Council:

KMPG has been rapped over the knuckles by the accounting watchdog for signing off on audits before all necessary work had been completed.

The criticism was made by the Financial Reporting Council as it told Deloitte, Ernst & Young, KMPG and PwC, the four biggest auditors, to do more to avoid conflicts of interest and be more sceptical of management claims.

The annual evaluations of the Big Four auditors comes amid increased regulatory scrutiny of the profession and its role in the financial crisis.

In the case of KPMG, the FRC’s Audit Inspection Unit looked at 15 audits and found that in three cases the auditor’s report had been signed too soon. Significant changes were subsequently made to the accounts in one case.

Paul George, director of auditing at the FRC’s Professional Oversight Board, which includes the AIU, said the early sign-off problem was not limited to KPMG: “It is a profession-wide challenge to some degree.”

KPMG said it accepted the AIU’s comments. “We are pleased to note that in no case did they think that the audit opinion we issued was incorrect,” said Oliver Tant, head of its UK audit arm.

The next day, popular Going Concern blogger Caleb Newquist was cynical of Oliver Tant’s remarks attempting to minimize the gravity of his firm’s negligence:

Okay, sure signing off early on 20% of the audits sampled sorta looks bad but at least the numbers weren’t wrong. It would be really awkward to explain that. 

KPMG was plain lucky that no audit opinions had to be changed as a result of their negligence. Back in my criminal days as main architect of the Crazy Eddie fraud, KPMG was not so lucky. If KPMG had taken the time to properly complete its filed work, they would have uncovered Crazy Eddie’s massive fraud.

How I duped KPMG back in my criminal days

In the hope of providing a wake up lesson to accounting firms like KPMG, below is my story about how I was able to dupe them into certifying Crazy Eddie’s financial reports before the completion of field work and giving Crazy Eddie a clean audit opinion in fiscal year 1987.

1987 was a year of desperation at Crazy Eddie

From the early 1970’s to 1984, Crazy Eddie was a profitable private company. Our frauds were focused primarily on understating our profits by skimming cash to commit income tax evasion and steal sales taxes.

In 1984, Crazy Eddie hired Main Hurdman as its auditors because we needed a large accounting firm to add a false sense of credibility to our financial reporting. In 1987, Main Hurdman merged with another large accounting firm Peat Marwick and was called Peat Marwick Main (PMM). Today, Main Hurdman and Peat Marwick are the US audit partners of large international accounting firm KPMG They are the “P” and “M” in KPMG.
 

As a public company from 1984 to 1986, our frauds concentrated on inflating profits or overstating income to help certain members of the Antar family ultimately sell about $100 million in stock at inflated prices.

However, in 1987, Crazy Eddie started losing money for the first time in almost two decades because of increased competition and a steep decline in consumer electronic prices which reduced revenues. We resorted to desperate measures to report profits instead of losses.

Fraudulently increasing the value of assets like inventories and fraudulently decreasing liabilities such as accounts payable or amounts owed to vendors inflates reported income or understates reported losses. We fraudulently inflated our inventories by approximately $30 million, but that feat was still not enough to avoid reporting massive losses. Therefore, we conceived of a plan to generate $20 million in phony debit memos which were supposed to be charge backs or offsets against amounts owed to vendors for such items as advertising rebates, volume discounts, and other reimbursements due the company. Those phony debit memos helped us show smaller accounts payable balances or lower amounts owed to vendors on our books and records.

Our accounts payable was only $70 million. Therefore, reducing our reported accounts payable by almost 30% through the issuance of $20 million in phony debit memos was a huge undertaking and we risked scrutiny of those debit memo from our auditors. However, we were desperately trying to cover up massive losses in 1987.

We needed to keep KPMG on a very short string

The lesser the amount of  time that KPMG (at that time called Peat Marwick Main) had available to audit Crazy Eddie’s books and records, the  easier it was for us to dupe them into issuing clean audit opinions on our falsified financial reports. It was my job to make sure that KPMG did not have enough time to properly complete its audit field work and appropriately examine Crazy Eddie’s books and records.

To accommodate Crazy Eddie’s management, KPMG regularly signed off on its audits about 60 days after our fiscal year ended. For example, in the fiscal year ended March 3, 1985, KPMG signed off on Crazy Eddie’s audit on May 2, 1985. KPMG signed off on Crazy Eddie’s fiscal year ended March 2, 1986 audit on May 1, 1986. Likewise, we hoped that KPMG would sign off on Crazy Eddie’s audit for the fiscal year ended March 1, 1987 on April 30, 1987 in following previous year’s practices.

Ultimately, I was successful in pressuring KPMG to sign off on Crazy Eddie’s 1987 audit on April 28, two days earlier than expected, despite the fact that major audit work was incomplete!

Note: Crazy Eddie’s fiscal year ended on the first Sunday in March which explains the difference in dates for the end of fiscal year’s 1985, 1986, and 1987.

Crazy Eddie’s audit was expected to last about eight weeks and KPMG planned to complete its field work in regular increments during that period. For example, by the sixth week (of eight), KPMG expected to have about 75% of its field work completed and 25% of its work left to do.

My job was to stall KMPG into having only 25% of its field work completed by week six and having 75% of its work left to do during the remaining two weeks of the eight week audit. Thus, KPMG had to do three times the usual amount of field work in the remaining two weeks. To get the work done and satisfy Crazy Eddie’s management, KPMG would skimp on certain key procedures. The plan worked!

Understanding the human frailties of auditors and taking advantage of them

As a general practice, most large accounting firms use relatively inexperienced kids right out of college to do much of the basic audit leg work. They are supervised by slightly more experienced senior auditors who unfortunately depend on feedback from these inexperienced kids in making informed decisions on the conduct of the audit. During the 1980s, both these kids and their supervisors were mostly young single males between the ages of 22 and 29.

As a 28 year old CPA myself, I understood that audits are very boring, tedious, and mundane for these young single male auditors. It was difficult for them to pay close attention to their work. It was relatively easy for me to distract them from performing their jobs without blaming me for stalling them or obstructing their audit work.

Photo from Going Concern blog

Rather than overtly obstructing our auditors’ field work, I engaged in a calculated plan to subtly distract them. I made sure that most of our auditor’s interactions were with cute Crazy Eddie female employees reporting to me, even if some of those females had no knowledge of our cooking the books.

I encouraged my female employees to flirt and get friendly with their young male KPMG counterparts and discuss audit issues with them over lunch and dinner on Crazy Eddie’s tab. Meanwhile, I spent much of my time taking certain higher level KPMG counterparts to pick up bars and other establishments frequented by good-looking women.

My female staffers provided the perfect distraction for KPMG auditors as they engaged in constant small talk and wasted precious time. By April 26, just a few days before the scheduled audit sign off, KPMG had not even started many key procedures and still had many unanswered questions.

Unanswered questions and unfinished audit work

In the previous fiscal year, 1986, we had falsified our store level inventories (not warehouse inventories) by $3 to $4 million. However, in fiscal year 1987, Crazy Eddie's store level inventories were inflated by $15 to $20 million as we desperately tried to cover up staggering losses.

In stores that existed in both 1986 and 1987, where the auditors observed inventory counts, those gross inventory levels increased from $21.95 million to $37.47 million or a staggering 71%, despite a huge drop in consumer electronic prices. On April 26, 1987, I was able to convince a certain audit partner not order a re-count of store inventories despite his questioning the unusual increase in store level inventories during a period of dropping prices.

Better yet, the audit test work on verifying the validity of $20 million of charge backs to vendors, which were actually phony debit memos, did not even start because of the effectiveness female employees in distracting the male auditors from doing their work. Moreover, the audit partner respected me as a responsive client and trusted me - a grave mistake.

In past years, I always gave in to his recommendations on being “conservative” and reducing reported income, even though I was only giving back the excesses of my inflated fraudulent numbers. I effectively played poker with a marked deck, giving back the cards I did not need. Therefore, I was able to convince that audit partner to sit on a board of directors meeting the next day on April 27, where the board approved Crazy Eddie’s numbers after questioning him and me.

On April 28, 1987, KPMG formally signed off on Crazy Eddie’s financial reports and issued a clean audit opinion, despite red flags in store inventory levels and uncompleted field work in verifying $70 million of accounts payable that was fraudulently reduced to $50 million by our issuance of $20 million in phony debit memos.

Taking advantage of the inexperience of our auditors

The audit staff member who was responsible for leg work on accounts payable had no prior experience in auditing accounts payable and only started working for KPMG six months earlier fresh out of college. He first learned about offsetting charge backs to vendors against amounts purportedly owed them or debit memos during the Crazy Eddie audit, much of it from me.

Since the audit was already officially completed, KPMG only examined the accounts payable or amounts owed by Crazy Eddie to three major vendors, out of thousands of possible vendors. Each of those three vendors reported significant discrepancies in amounts they claimed that Crazy Eddie owed them due to our issuance of phony charge backs to vendors or debit memos.

For example, Sony claimed that Crazy Eddie owed them about $5 million more than Crazy Eddie claimed it owed them because Sony never acknowledged receiving any such debit memos. The auditors never did any follow up contact with any of the companies, whose accounts payable balances they examined, concerning any discrepancies in amounts owed by Crazy Eddie.

On April 28, 1987, the inexperienced auditor finally started his test work on Sony (which contained about $5 million of the $20 million in phony debit memos), the very same day our auditors signed off on the audit according to his testimony in a sworn deposition.

The questions below were asked by Stephen Howard, Attorney from Milbank, Tweed, Hadley, & McCloy, who represented the Oppenheimer-Palmieri Fund, L.P., one of the major shareholders who in November 2007 took over Crazy Eddie in a hostile takeover:

Question: There’s a date at the bottom of the page which appears to be 4/28/87. Do you see that?

KPMG staffer: Yes, I do.

Question: Is that your handwriting.

KPMG staffer: Yes, it is.

Question: What does that signify?

KPMG staffer: It was my policy to date my workpapers when I began to perform test work.

Question: So that tells us you started this work on the 28th but it doesn’t tell us when you finished it?

KPMG staffer: That is correct.

In his other sworn testimony, young inexperienced auditor said that he continued his field work for more than one day, but couldn’t recall how many days it took for him to complete his work. In any case, KPMG already had signed off on Crazy Eddie’s audit.  KPMG had no incentive to do any additional significant field work that may cause them to change their audit opinion.
  
Key audit procedures missed

Crazy Eddie Antar mug shot after arrest

In previous years, we generated an accounts payable aging schedule for our auditors to review. That schedule provides detailed information about every invoice owed to vendors, any offsetting charge backs to vendors such as debit memos, and how long those items have remained outstanding.

However, for fiscal year 1987, we did not generate accounts payable aging analysis.  Therefore, our auditors were unable to determine the how long the phony debit memos were on Crazy Eddie's book and records and why, after the passage of time,  they were not used as an offset against payments to vendors.
  
In addition, the sheer volume of phony debit memos caused our books and records to show many vendors owing Crazy Eddie money, rather than the other way around! Those negative accounts payable balances were red flags that were never properly scrutinized by our auditors.

An excerpt from KPMG’s work papers said:

... traced all debit memos into A/P status report as of 03/01/87. No further work necessary.

An “A/P status report” simply lists all invoices owed to vendors and offsetting debit memos. Therefore, the debit memos were traced to a report listing the phony debit memo, in other words known as “garbage in, garbage out.” Our auditors simply traced the phony debit memos to the books and records that reflected them, but did no work to confirm the validity of those debit memos.

Weeks later, a senior staff member finally did conduct an interview of Crazy Eddie's Accounts Payable Manager (a female co-conspirator) and his work paper is dated May 22, 1987 or 24 days after KPMG issued its clean audit opinion of Crazy Eddie’s books and records.

Conclusion

KPMG may have dodged the bullet by not having to change any of its audit reports as a result of its recent failure in “signing off on audits before all necessary work had been completed.” If history is any guide, KPMG demonstratively failed to learn the lesson of their misdeeds during the Crazy Eddie audit. I wonder if they are at least better in covering up their mistakes this time around.

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 our 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 valiant 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. As an independent whistleblower, I often refer cases to them.

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.

Hopefully, this blog post can get me into heaven, though I doubt I will ever get there.

Patrick Byrne Pockets $3.1 Million from Dumping Overstock.com Shares While Trying to Stave Off Possible SEC Enforcement Action

Patrick Byrne intoxicated after drinking too much alcohol

Amidst an ongoing Securities and Exchange Commission investigation into financial reporting violations by Overstock.com (NASDAQ: OSTK), CEO Patrick Byrne's 100% controlled High Plains Investments LLC dumped 140,000 company shares and collected over $3 million in proceeds during the last several days, according to SEC filings. This marks the first time that Patrick Byrne has ever sold any Overstock.com shares under his control, not a bullish signal to investors.

Meanwhile, the company is desperately trying to stave off an enforcement action by the SEC. Before I discuss that issue, let's review some recent history.

Why the SEC is Investigating Overstock.com

So far, each and every initial financial report for every reporting period issued by Overstock.com from the company's inception in 1999 to Q3 2009 violated GAAP or some other SEC disclosure rules. Likewise, every single audit report issued by PricewaterhouseCoopers, Overstock.com's former auditors, from 1999 to 2008 was wrong turned out to be false, too. In addition, information uncovered by investigative journalist Roddy Boyd shows that managment deliberately concealed material weaknesses in internal controls over financial reporting as far back as 2005.

More recently, during 2009, I detailed how Overstock.com deliberately violated Generally Accepted Accounting Principles (GAAP) in recognizing income for recoveries from underbilled and overpaid fulfillment partners by improperly claiming that a “gain contingency” existed when it did not actually exist under accounting rules.

Under GAAP, Overstock.com is required to recognize income from underbilling and overpaying its fulfillment partners when such income was actually earned (before Q3 2008). By improperly claiming that a “gain contingency” existed, Overstock.com improperly recognized income as monies were recovered from the underbilled and overpaid fulfillment partners in future reporting periods on a non-GAAP cash basis. Therefore, Overstock.com improperly shifted income earned before Q3 2008 to future accounting periods (Q4 2008 to Q3 2009). In Q4 2008, Overstock.com improperly reported a $1.014 profit, instead of a $750k because of GAAP violations.

Creepy Judd Bagley

I notified both the company and the SEC of Overstock.com's improper accounting for recoveries from underbilled fulfillment partners and later on, for overpaid fulfillment partners. Instead of properly complying with GAAP, Overstock.com CEO Patrick Byrne defamed me in various quarterly conference calls with analysts and investors, sent his paid internet stalker Judd Bagley to interfere in my divorce proceedings, and even had Bagley and spy on my family and other company critics (including our minor family members) using a fake Facebook name.

In September 2009, the SEC re-opened a previously closed investigation of Overstock.com after I notified them of violations of Generally Accepted Accounting Principles (GAAP) in the company's reporting of recoveries from previously underbilled fulfillment partners.

In November 2009, Overstock.com fired Grant Thornton as its auditors after they recommended that the company restate its financial reports to correct GAAP violations, as I previously called for in my blog. In December 2009, KPMG replaced Grant Thornton as Overstock.com's auditors.

On January 29, 2010, Overstock.com finally admitted that its accounting for recoveries from underbilled and overpaid fulfillment partners was "inappropriate" and that no gain contingency existed, as I previously reported in my blog.

On March 31, 2010, Overstock.com's 2009 10-K report restated the company's Q4 2008 financial report to show a properly reported net loss rather than an improper net profit, as I correctly said it should in my blog more than a year earlier. However, a few days later, Patrick Byrne falsely claimed to AP reporter Paul Foy that "Overstock's accounting errors were generally conservative...and gave the company no advantage."

In its Q1 2010 10-Q report, Overstock.com reported continuing material weaknesses in internal controls.

Overstock.com's Current Discussions with SEC

According to certain sources, Overstock.com is currently trying to stave off an enforcement action from the Securities and Exchange Commission by claiming that management had no "intent" to violate GAAP and other SEC disclosure rules and that its history of financial reporting problems was a result of incompetent staffing. I find it hard to believe that any rational person the SEC could be so stupid as to believe such nonsense from company paid lawyers.

How can Overstock.com claim a "lack of intent" when its management defiantly failed to promptly correct GAAP violations when notified by me and later fired Grant Thornton as its auditors, rather than correct those GAAP violations? Worse yet, the company engaged in a vicious campaign to stalk, harass, and intimidate me and other media critics. The company even spied on me, other critics, and our families.

If the SEC fails to take action against Overstock.com, it will send a clear message that whistleblowers who correctly point out securities law violations are still not welcome despite the regulator's widely publicized bungled investigation of Bernie Madoff, after they ignored whistleblower Harry Markopolos.

As I said in my last open letter to Chairperson Mary Schapiro, "The SEC has an excellent chance on its second investigation of Overstock.com to regain that lost public confidence by bringing a successful enforcement action against Overstock.com, its Audit Committee, and its management team for securities law violations, including Rule 10b-5."

Written by:

Sam E. Antar

Recommended Reading (Especially for the SEC Commissioners, Lawyers, and Investigators)

Gary Weiss - Patrick Byrne Dumps His Overstocked Overstock Shares by Gary Weiss

The Big Picture - Long OSTK, Short Byrne by Barry Ritholtz
May 26, 2010: Going Concern - Why Did Patrick Byrne Sell $3 million in Overstock.com Shares? by Caleb Newquist

May 26, 2010: Jr Deputy Accountant - It's Not at All Suspicious That Patrick Byrne Just Unloaded a Bunch of Overstock Shares by Adrienne Gonzalez

Selling America Short: The SEC and Market Contrarians in the Age of Absurdity by Richard Sauer (Wiley 2010) - Chapter 12: The Overstock Flame Wars

Stockwatch - Overstock.com faces another shoddy accounting challenge by Lee M. Webb

Crain's New York Business - Crazy Like a Fox by Aaron Elstein (Download)

Disclosure

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

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven. However, I doubt that I will ever get into heaven anyway, because my sins are unforgivable. I will probably end up joining corporate miscreants such as fifth rate crooks like Patrick Byrne in hell.

In any case, exposing Overstock.com's financial reporting violations is a lot of fun and analyzing the company's financial reporting is a forensic accountant's wet dream.

Are InterOil's Auditors Capable of Finding Fraud in Plain Sight?

Fraud Discovery Institute (co-founded by convicted felon turned fraud buster Barry Minkow) is putting PricewaterhouseCoopers (PwC), InterOil's (NYSE: IOC) auditors, on notice that they must look out for possible fraud by the company as required by Statement of Auditing Standards No. 99. Fraud Discovery released a video to provide a road map to PwC "in an attempt to give investors clearer picture of the inside workings of the controversial company." Minkow believes that InterOil is "a financial crime in progress." In addition, former LA Times investigative reporter William Lobdell, who now writes for Fraud Discovery's iBusiness Reporting blog, issued a report detailing a "troubling pattern of behavior" by InterOil since its founding in 1997.




However, I am skeptical about PwC's capability to find any fraud at InterOil based on my prior experience with them as the auditors of Overstock.com (NASDAQ: OSTK) another scam company investigated in this blog. I correctly identified certain GAAP and SEC disclosure violations by Overstock.com and PwC still certified the company's financial reports as being in compliance with GAAP and SEC rules. A year later, Overstock.com admitted to those same GAAP and SEC disclosure violations exposed in my blog and restated its financial reports to correct its violations.

Both Barry Minkow and William Lobdell have publicly disclosed holding short positions in InterOil securities. I do research for Fraud Discovery on InterOil and I do not own any securities in InterOil, long or short. More disclosure at the bottom of this blog post.

Statement of Auditing Standards: Consideration of Fraud in a Financial Audit

According to SAS No. 99, "The cornerstone of an effective antifraud environment is a culture with a strong value system founded on integrity." Unethical behavior by company management is considered a red flag for possible fraud and auditors are required to increase the scope of their audits to detect potential fraud to insure that financial reports are free from material errors. Fraud Discovery Institute's InterNoOil.com website and its iBusiness Reporting blog have published many reports detailing a troubling pattern questionable behavior by InterOil management.

Forensic accountants look for a "pattern of inconsistent and conflicting disclosures" in investigating fraud at public companies, like InterOil. Likewise, PricewaterhouseCoopers is required by SAS No. 99 to look at "inconsistent and conflicting disclosures" to determine if InterOil is committing fraud, such as those described below.

Previous examples of a "pattern of inconsistent and conflicting disclosures" by InterOil

In my June 2009 blog post entitled, "InterOil, John Thomas Financial, and Clarion Finanz: Anatomy of a Stock Market Manipulation Scheme," I detailed how InterOil filed a false report with the Securities and Exchange Commission claiming that the company paid no fees for a private placement $95 million convertible debt offering. However, documents submitted in another court case reveal that Clarion Finanz (a major shareholder of InterOil) had in fact received $5.7 million in fees, contrary to InterOil's SEC filings.

In March 2010, William Lobdell went to a Texas courthouse to examine documents filed in a litigation by the original investors of InterOil against CEO Phil Mulacek alleging fraud by him dating as far back as 1997 (Details here, here, and here).

In another blog post, entitled, "Did InterOil Commit Securities Fraud?" I detailed how CEO Phil Mulacek made sworn statements in that court case which conflicted with InterOil's financial disclosures to investors. In his sworn court testimony, Mulacek claimed that a $50 million judgment against InterOil would bankrupt the company, while InterOil's financial disclosures to investors claimed that a judgment in excess of $125 million would have a material adverse impact on the company.

Under SAS No. 99, "Misrepresentation in or intentional omission from the financial statements of events, transactions, or other significant information" is considered "relevant to the auditor's consideration of fraud." In both of the situations cited above, InterOil told one story to investors in its SEC filings and financial reports and its management told a conflicting story to the courts in sworn statements. If one story is true, the other story simply cannot be true. In each of the cases cited above, InterOil misrepresented or omitted material information in its financial reports to investors, as evidenced by its management's conflicting disclosures to the courts.

Based on InterOil's conflicting disclosures, PwC is required to investigate such irregularities under SAS No. 99, as part of its audit of the company. However, I am skeptical of PwC's auditing abilities and it's capability to uncover any fraud committed by clients such as InterOil. So far, they seem to have ignored significant management integrity issues at InterOil, like the two issues detailed above.

Why I am skeptical about PwC's capability to find fraud at InterOil

PwC was Overstock.com's auditors from 1999 to 2008. During that period, every initial financial report for every reporting period issued by Overstock.com and reviewed or audited by PwC violated Generally Accepted Accounting Principles (GAAP) or some other SEC disclosure rules. Overstock.com CEO Patrick Byrne blatantly lied to investors over a ten year period about the company's financial performance, internal controls, and compliance with GAAP and other SEC disclosure rules.

Starting in February 2009, I wrote a series of blog posts correctly identifying certain GAAP violations by Overstock.com in 2008 and prior years. Both Overstock.com and PwC ignored my requests for them to correct those GAAP violations and restate the company's financial reports. Patrick Byrne responded by orchestrating a smear campaign to discredit me and other critics who agreed with my findings, while PwC improperly certified the company's financial reports as being in compliance with GAAP.

In March 2009, Overstock.com hired Grant Thornton to replace PwC as its auditors. In September 2009, the SEC started investigating Overstock.com's accounting irregularities that were pointed out in my blog. In November 2009, Overstock.com fired Grant Thornton after they agreed that I correctly identified certain GAAP violations and wanted the company to restate its financial reports. PwC still stuck to its guns and claimed that Overstock.com did not violate GAAP.

In December 2009, Overstock.com hired KPMG to replace Grant Thornton. In February 2010, Overstock.com finally admitted that the company violated GAAP and restated its financial reports to correct GAAP violations, previously identified by me. I was right and Overstock.com and PwC was wrong.

Overstock.com's financial reports that were audited by PwC were restated three times in ten years and every single audit report issued by PwC was wrong. PwC ignored serious management integrity issues at Overstock.com and I have no reason to believe that they will address any management integrity issues at InterOil.

A "troubling pattern of behavior" by InterOil

William Lobdell's latest report details even more questionable behavior by InterOil's management team. Lobdell cites "InterOil’s 12 years of hyping gas and oil fields in Papua New Guinea" and points out that InterOil still has no proven commercially exploitable reserves to date. Lobdell lists ten wells that InterOil hyped to investors, only to abandon them later on.

Many short sellers, including Minkow and Lobdell, are skeptical of InterOil's claimed estimates of contingent resources (not proven reserves). Lobdell examined the track record of GLJ Engineering, a firm hired by InterOil in 2009 to estimate its oil and gas resources. He found three major blunders by GLJ in the past and questioned the reliability of their reports on InterOil.

Then, Lobdell details how InterOil was apparently shopping for a favorable engineering report on its reserves before the company hired GLJ:

InterOil’s Netherland Sewell report is MIA.

GLJ's past mistakes might not be that much of an issue if it weren't for the "Case of the Missing Netherland Sewell Report."

In March 2007, InterOil CEO Phil Mulacek told attendees at a Raymond James conference in Orlando, Florida that three "world-class" firms were in the process of performing reserve analysis on InterOil gas fields. Mulacek named one firm, the iconic Netherland Sewell, stating that InterOil had hired the company, according to a reliable source.

This news of an imminent evaluation from Netherland Sewell was frequently mentioned in fawning investor reports by Raymond James and on blogs and message boards promoting InterOil.

But the report never came.

About 17 months later, Mulacek indicated in a conference call to investors that an international firm hired by InterOil would finish its reserve analysis report by the end of October 2008.

Again, the report never came.

So what happened to the Netherland Sewell report? Netherland Sewell nor InterOil will comment. And since InterOil is never shy about releasing good news, this should be worrisome to investors.

In the balance of his report, William Lobdell takes issue with InterOil's hype on the company's long term viability. He analyzes how InterOil is running out of cash and questions and other roadblocks facing the company in the future.

Closing comments

I cannot understand how auditing firms like PwC with their access to a company's books and records can miss red flags and financial reporting violations correctly pointed out by outsiders such as short sellers like Barry Minkow and William Lobdell and independent whistleblowers like me. Unlike us, PwC seems to be incapable of finding fraud, even fraud in plain sight .It seems that the reliability of PwC's audit reports is nothing more than pot luck in most cases.

Written by:

Sam E. Antar

Disclosure:

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

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway.

I do research on InterOil for Fraud Discovery Institute. However, I do not own any InterOil securities, short or long.

I plan on meeting corporate miscreants, such as fifth rate crooks like Patrick Byrne, in hell. In addition, it is likely that InterOil CEO Phil Mulacek may join Patrick Byrne and me in hell, too. We will all fry together.

Overstock.com's New 10-K Report Reveals Management Deceptions, Major Internal Control Problems, and Zero Quality Earnings

Patrick Byrne is suffering a hangover

Yesterday's release of Overstock.com's two week overdue 2009 10-K report and Q4 2009 financial report provide further vindication of this blog's identification of the company's violations of Generally Accepted Accounting Principles (GAAP) that improperly turned its Q4 2008 loss into a reported profit. In that quarter, Overstock.com improperly reported its first quarterly profit after fifteen consecutive quarterly losses, improperly exceeded analysts' consensus expectations for earnings, and improperly turned a loss into a profit.

If Overstock.com would have properly followed GAAP in Q4 2008, the company (1) would have reported a net loss instead of a net profit, (2) would have reported sixteen consecutive losses instead of 15 consecutive losses, and (3) it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).

As I will describe below, both Overstock.com CEO Patrick M. Byrne and company President Jonathan E. Johnson made false statements about the possible impact of certain questionable accounting practices on the company's previously issued financial reports in a deliberate effort to avoid restating the company's financial reports to comply with GAAP.

Afterwards, I will detail a disturbing stupid financial reporting error and provide a brief analysis of the smoke and mirrors that helped Overstock.com report its first annual profit.

Brief Background - Overstock.com's Illegal "Cookie Jar" Reserves

In October 2008, Overstock.com restated its financial reports from Q1 2003 to Q3 2008 to correct certain customer refund and credit errors. It was the second time in two years that Overstock.com had to restate its financial reports to comply with GAAP.

In February 2009, I correctly reported in my blog that the October 2008 restatement did not include corrections arising from underbilled offsetting costs and reimbursements that were already earned from its fulfillment partners during those same corresponding periods, less a reasonable estimate of uncollectable amounts.

Overstock.com should have gone back and corrected or restated its financial reports to reflect income already earned from offsetting costs and reimbursements due from its fulfillment partners, less a reasonable estimate for uncollectable amounts (See SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8 and 23).

Instead, Overstock.com improperly deferred income that it earned but underbilled its fulfillment partners during prior reporting periods (Q3 2008 and before) to by moving such income to future reporting periods (Q4 2008, Q1 2009, Q2 2009, and Q3 2009). In other words, Overstock.com took income that should have been reported in prior reporting periods (Q3 2008 and before) and moved it to future reporting periods (Q4 2008 and later) to materially overstate its financial performance in those later reporting periods.

In effect, Overstock.com violated GAAP by creating an illegal cookie jar reserve to materially inflate future earnings or reduce future losses from Q4 2008 to Q3 2009.

Overstock.com ridiculously claimed that the collection of the entire amount of its underbillings (every single penny) “was not assured” and instead falsely claimed that a "gain contingency" existed rather than make a reasonable estimate of uncollectable amounts as required under SFAS No. 5. Therefore, Overstock.com improperly recognized income from underbilled fulfillment partners as amounts due to the company were collected on a non-GAAP cash basis, rather when they were earned under accrual accounting or GAAP. (More details can be found in my Open Letter to the Securities and Exchange Commission here).

Overstock.com's Stubborn Refusal to Comply with GAAP

Starting in February 2009, I notified both Overstock.com and the SEC about the company's illegal "cookie jar" reserve and its phony "gain contingency." Based on information available at the time, I initially calculated that Overstock.com improperly reported a Q4 2008 net profit of $1.014 million, instead of a properly reported net loss of $800k. As a result of violating GAAP, Patrick Byrne was able to boast that the company reported its first quarterly profit after fifteen consecutive quarterly losses.

Patrick Byrne responded to my blog by claiming that:

Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.

Instead of properly restating its financial reports to correct its intentional breach of GAAP and other SEC disclosure rules, Overstock.com continued to issue phony financial reports in Q1, Q2, and Q3 2009 while publicly vilifying me.

In September 17, 2009, the SEC Enforcement Division took a very rare step and re-opened a previously closed probe of financial reporting irregularities at Overstock.com. A few weeks later, the SEC Division of Corporation Finance started a parallel probe of the company's financial reporting irregularities.

A September 25, 2009, Salt Lake Tribune article quoted Patrick Byrne's reaction to the SEC investigation instigated by my blog reports detailing GAAP and SEC disclosure violations:

"Gary Weiss and Sam Antar are goniffs," Byrne declared, using a yiddish term that he says means "a con man, a hustler and a scoundrel."

If the SEC is listening to them, their next step is to let Bernie Madoff write their indictment of me." Byrne was referring to the mastermind, now in prison, of a multibillion-dollar fraud whose case helped show how laissez faire Wall Street regulators had become.

In October 2009, the SEC Division of Corporation Finance discovered that Overstock.com overpaid a fulfillment partner $785,000 during 2008. The company recovered that overpayment in Q1 2009 and improperly reported the overpayment recovery as income in that same quarter, rather than properly restate its 2008 financial reports to correct that error.

Overstock.com improperly concealed the recovery of the overpayment by including that amount in recoveries from underbilled fulfillment partners in Q1 2009 instead of separately disclosing the overpayment recovery in its financial reports.

Grant Thornton claimed that it did not know about the 2008 overpayment and Q1 2009 recovery from the fulfillment partner until October 2009. After learning details about the overpayment, Grant Thornton told Overstock.com that it must restate its prior financial reports to correct that error and other underbilling errors previously indentified in this blog to comply with GAAP.

On November 13, 2009, Overstock.com fired and publicly vilified Grant Thornton, rather than restate its financial reports as its auditors and this blog had recommended.

On November 16, 2009 filed an "unreviewed" Q3 2009 10-Q that finally disclosed the overpayment to the fulfillment partner. However, Overstock.com still improperly claimed that a "gain contingency" existed as justification for not restating its financial reports to correct its previously reported underbilling errors and newly disclosed overpayment errors.

On November 18, 2009, during a conference call Patrick Byrne tried to justify Overstock.com's improper accounting of recoveries from underbilled fulfillment partners, overpaid fulfillment partners, and other overpaid vendors that were reported as income on a non-GAAP cash basis. He falsely claimed that even if Overstock.com changed its accounting for underbilling and overpayment recoveries, it would not change any previously reported profit into a loss or any previously reported loss into a profit:

In fact, we as I understand it, this doesn't change any positive quarter to a negative quarter or any negative quarter to a positive quarter.

In a November 25, 2009 Salt Lake Tribune article, Jonathan Johnson was quoted as saying:

None of these changes that they [Grant Thornton] are talking about, or that people at the SEC are now asking about, make any of our quarters go from negative to positive or from positive to negative.

A day later, I posted in my blog new calculations of the impact of Overstock.com's GAAP violations on Q4 2008 to counter both Byrne's and Johnson's false statements to the Salt Lake Tribune, based on revised disclosures in the company's Q3 2009 "unreviewed" 10-Q report. This time I reported that Overstock.com improperly reported net profit of $1.014 million should have been properly reported as a $485k net loss.

On December 28, 2009, KPMG replaced Grant Thornton as Overstock.com's auditors.

Vindication I

On January 29, 2010 Overstock.com finally ate crow and admitted that its accounting for recoveries from both underbilled and overpaid fulfillment partners was "inappropriate" and that no gain contingency existed, as I previously reported in my blog.

The company reported that its financial reports from Q1 2008 to Q3 2009 "should no longer be relied upon" and that it will restate its financial reports to correct its GAAP violations. In addition, Overstock.com disclosed another GAAP violation due to its improper amortization of expenses for share-based compensation plans.

Simply said, I was right and Overstock.com was wrong. I was able to identify material GAAP and SEC disclosure violations that Overstock.com's management, its audit committee, and its former auditors at PricewaterhouseCoopers were unable and unwilling to identify and correct.

Late Filing of 2009 10-K Report

On March 16, 2010, Overstock.com announced that it could not file its 2009 10-K report by that day's deadline. The company required a two week extension to complete its financial reports.

However, Overstock.com nonchalantly disclosed even more GAAP violations "in its notification of late filing" that were previously undisclosed by the company. Overstock.com falsely claimed that those errors were previously disclosed by the company on January 29, when the company announced that it was restating its financial reports to comply with GAAP as described above.

Vindication II

On March 31, 2010 Overstock.com filed its 2009 10-K report and Q4 2009 financial report. Overstock.com's financial disclosures revealed that company improperly reported a Q4 2008 net profit of $1.014 million instead of a properly reported Q4 2008 net loss of $705k (See page F-53).

Excluding relatively minor adjustments relating to new GAAP violations reported by Overstock.com, I was right again and Patrick Byrne and Jonathan Johnson were entirely wrong again. I calculated that Overstock.com would report a loss in Q4 2008 if the company properly followed GAAP. In contrast, both Byrne and Johnson falsely stated that none of those questionable accounting practices turned a loss into a reported profit.

Byrne and Johnson, as the principal officers of Overstock.com had the means to make the same calculations I did. They both knew that any accounting error that turns a properly reported loss into an improperly reported profit is grounds for an automatic restatement of financial reports to correct such errors. Instead, they lied to investors in a deliberate attempt to hide the material financial impact of the company's GAAP violations to avoid restating the company's financial reports to correct those violations.

As I have said many times before, each and every initial financial report for every reporting period issued by Overstock.com from its inception in 1999 to Q3 2009 turned out to violate GAAP or some other SEC disclosure rules. Likewise, every single audit report from 1999 to 2008 was wrong and every single Sarbanes-Oxley internal control certification signed by management turned out to be false. The company's audit committee is as useless as Crazy Eddie's audit committee was, back in the day. So far, Overstock.com has restated its financial reports three times to correct GAAP violations.

Screwed up Internal Controls Cost Millions

KPMG issued "an adverse opinion "on the effectiveness of the Company's internal control over financial reporting."

Even though Overstock.com seems to have corrected certain GAAP violations, the company revealed that during 2009 it continued to underbill its fulfillment partners approximately $1.2 million but will "to not seek recovery of these amounts from our fulfillment partners."

Previously, Overstock.com disclosed that it underbilled its fulfillment partners $2.8 million in 2007 and $2.7 million in 2008. The company claims that it recovered none of the underbilling originating in 2007 and $2.3 million of the underbilling originating in 2008.

Therefore, from 2007 to 2009 literally $4.4 million of earned income walked out the door - 2007: $2.8 million, 2008: $400k, and 2009: $1.2 million.

New Financial Disclosure Errors Uncovered by Gary Weiss

Investors still cannot be comfortable with the credibility of Overstock.com's financial reporting.

For example, investigative reporter, bestselling author, and blogger Gary Weiss just browsed through Overstock.com's 2009 10-K report and uncovered yet another unsettling financial reporting error by Overstock.com. See below:

...the Marin County District Attorney and four other DAs in northern California want the company to fork over $8.5 million to settle consumer ripoffs by Overstock. The company disagrees and is fighting it, so .... No, wait a moment, make that read "$7.5 million." It uses the smaller number on page F-37 and the bigger number on page 33.

Really. Here it is. Page 33:

In January 2010 attorneys for the Company received correspondence from the Office of the District Attorney of County of Santa Clara in which the respective offices of the various district attorneys have made a collective proposal to resolve the dispute by the Company's payment of $8,500,000 in penalties and reimbursement.

Page F-37:

The Company 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 the Company's payment of $7,500,000 in penalties and reimbursement.

Hey what's a million here or there when your numbers are already fabricated, right? Anyway, I'm sure glad they asked for that delay to get their numbers straight.

By the way, California made this demand back in January. Isn't it charming how Overstock didn't bother filing an 8-K saying that people who can put you in jail want $8.5 million/$7.5 million? As I've said before, Overstock's not big on niceties of the securities laws, particularly the ones concerning "fraud," "ethics" and "disclosure."

Apparently, Overstock.com's management, its audit committee, and its auditors are simply incapable of simply proof reading its financial reports.

Here's another unsettling misleading disclosure error under the caption "Risk Factors: and I am not joking:

Public statements we or our chief executive officer, Patrick M. Byrne, have made or may make in the future may antagonize regulatory officials or others.

We and our chief executive officer, Patrick M. Byrne, have from time to time made public statements regarding our or his beliefs about matters of public interest, including statements regarding naked short selling. Some of those public statements have been critical of the Securities and Exchange Commission and other regulatory agencies. These public statements may have consequences for us, whether as a result of increased regulatory scrutiny or otherwise.

Overstock.com should revise that disclosure to state that it's the lies told to investors by Patrick Byrne and his deliberate unwillingness to comply with GAAP and other SEC disclosure rules which are the company's biggest risk factors.

Smoke and Mirrors behind Overstock.com Reported 2009 Net Profit

Overstock.com reported a 2009 first time annual profit of $7.7 million. However, a careful study of the company's financial disclosures reveals that its profit is derived from one-time nonrecurring items or other non-operating items. See below:

• Gain from extinguishment of debt (Consolidated Statement of Cash Flows): $2.8 million
• Gain from settlements of legal matters (Footnote 16: Commitments and Contingencies): $7.1 million
• Reduction of sales return allowances $4.3 million (Page F-16) which added $900k to profits
• Total: $10.8 million

Without the above items, Overstock.com's 2009 reported $7.7 million net profit disappears into a $3.1 million loss.

Overstock.com's debt was issued in 2004 under false pretenses. Financial reports issued by Overstock.com prior to the issuance of such debt were restated twice by the company due to material GAAP violations. In other words, Overstock.com repurchased debt at a profit that was originally issued to investors on the basis of financial reports that violated GAAP.

The gains in settlements of legal matters merely reflect to a large extent Overstock.com's recoupment of costs previously incurred in litigation.

The significant reduction of sales return allowances is a change in estimate. In others words, previously reported sales return allowances by the company may have been overstated. A downward revision of such an estimate creates a temporary book profit.

New Loss Contingencies

In its 2009 10-K report, Overstock.com disclosed new loss contingencies that could put a big hole in its corporate pockets (Footnote 16: Commitments and Contingencies):

• District Attorneys of Marin and four other counties in Northern California to settle investigation into advertising practices: $8.5 million.
• Ohio taxes: $613k
• Total potential future losses: $9.13 million

Conclusion

With the SEC investigation of Overstock.com continuing, KPMG took a huge risk in certifying the company's 2009 financial reports. Apparently, KPMG needs a refresher course on Statement of Auditing Standards No. 99 that deals with management teams that lack integrity like the executives running Overstock.com. There are many black holes in Overstock.com's financial reporting that KPMG may not be aware of. Those black holes will be the subject of future blog posts.

Note:

On 10/26/10, I updated certain amounts relating to sales return allowances based on new clarified disclosures by Overstock.com resulting from an SEC Division of Corporation Finance inquiry.

Written by:

Sam E. Antar

Disclosure:

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

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway. I will probably end up joining corporate miscreants such as Patrick Byrne in hell.

In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me. Analyzing Overstock.com's financial reporting is a forensic accountant's wet dream and Patrick Byrne is about to become the SEC's new orgasm.