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.

Green Mountain Coffee Roasters, Time to Spill the Beans?

To truly exonerate itself after the discovery of certain material violations of Generally Accepted Accounting Principles (GAAP), Green Mountain Coffee Roasters (NASDAQ: GMCR) needs to come clean with investors and disclose exactly when it found certain accounting errors. In addition, Green Mountain needs to provide clearer and more transparent disclosures to investors about the Securities and Exchange Commission (SEC) inquiry and the discovery of those errors.

Timing of certain disclosures

On Monday, September 20, 2010, the SEC notified Green Mountain Coffee Roasters that it was conducting an informal inquiry and requested it voluntarily submit information concerning “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.”

Eight days later, on September 28, 2010, Green Mountain surprised investors by disclosing news of the SEC inquiry in an 8-K filing with the SEC. In that same 8-K report, Green Mountain disclosed that it discovered an "immaterial accounting error" affecting financial reports issued from 2007 to 2010:

In connection with the preparation of its financial results for its fourth fiscal quarter, the Company’s management discovered an immaterial accounting error relating to the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit. Management discovered that the gross margin percentage used to eliminate the inter-company markup resulted in a lower margin applied to the Keurig ending inventory balance effectively overstating consolidated inventory and understating cost of sales. Management determined that the accounting error arose during fiscal 2007 and analyzed the quantitative impact from that point forward to June 26, 2010.

As of June 26, 2010, there is a cumulative $7.6 million overstatement of pre-tax income. Net of tax, the cumulative error resulted in a $4.4 million overstatement of net income or a $0.03 cumulative impact on earnings per share.

After evaluating the quantitative and qualitative aspects of the error in accordance with applicable accounting literature, including Staff Accounting Bulletins published by the SEC, the Company, with the participation of the audit committee of the Board of Directors, has determined that the correction in the margin calculation represents a correction of an error in accordance with Accounting Standards Codification 250 Accounting Changes and Error Corrections, that the correction was not material to the fiscal years and the respective quarters ended 2007, 2008 and 2009 and that the Company anticipates that the correction will not be material to fiscal year 2010 and the respective quarters of fiscal 2010. As a result, the Company anticipates the cumulative amount of the accounting correction will be made in the quarter ended September 25, 2010. [Bold and italicized emphasis added.]

Green Mountain did not disclose exactly when it discovered the margin error but only that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter…..” Green Mountain’s fiscal year ended on September 25, 2010. Usually companies prepare for their year-end audits up to two months in advance.

Two scenarios

If Green Mountain had discovered the margin error before it was notified about the SEC inquiry, on September 20, 2010, why didn’t the company disclose the margin error to investors earlier, instead of waiting until it filed its 8-K report September 28, 2010?

If Green Mountain discovered the margin error after it was notified about the SEC inquiry, on September 20, 2010, why was the company able to find an accounting error within eight days or by September 28, 2010, when it didn't find the error during the previous fiscal years (2007 to 2010)? This scenario is possible, but it would be very coincidental.

The unknown timing of Green Mountain’s discovery of its margin error raises the question: did the company disclose the error to investors when it was discovered or did the company wait?

Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza S.p.A.

In that same September 28, 2010 8-K report, Green Mountain disclosed that it closed its Common Stock Purchase Agreement with Luigi Lavazza S.p.A. See below:

On September 28, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (the “Company”), completed a sale of 8,566,649 shares (the “Shares”) of its common stock, par value $0.10 per share (“Common Stock”), to Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), for an aggregate purchase price of $250,000,000. The sale of the Shares was effected pursuant to the Common Stock Purchase Agreement, dated as of August 10, 2010 (the “SPA”), by and between the Company and Lavazza. The execution of the SPA was previously reported by the Company in its Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission (the “SEC”) on August 11, 2010, and the full text of the SPA was filed as Exhibit 10.1 thereto. 

In connection with the stock purchase agreement, Green Mountain provided certain warranties that the Company and its auditors have not identified and are not aware of:

(A) any significant deficiency or material weakness in the design or operation of internal control over financial reporting utilized by the Company; (B) any illegal act or fraud, that involves the Company’s management or other employees; or (C) any claim or allegation regarding any of the foregoing that would have a Material Adverse Effect. [Bold and italicized emphasis added.]

According to Statement of Auditing Standards No. 115:

.07 A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.

A material weakness in internal controls generally arises when accounting errors have a “reasonable possibility” of causing a company to restate its financial reports to correct those errors. A "significant deficiency" in internal controls arises when accounting errors are not material enough to cause a restatement of financial reports, but are instead corrected by making a cumulative adjustment to the latest period’s financial reports.

Initially, Green Mountain claimed that its margin error was “immaterial” and disclosed that it would correct that error by making a cumulative adjustment to its Q4 2010 financial reports, rather than restate its financial reports issued from 2007 to 2010. At the very least, that margin error appeared to result from a “significant deficiency” under auditing rules. It could be a breach of warranty under Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza, though Green Mountain never told investors that may have breached a key warranty under its agreement with Luigi Lavazza.

Green Mountain initially entered into its agreement to sell shares to Luigi Lavazza on August 10, 2010. On the following day, Green Mountain disclosed to investors that:

On August 10, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (“Green Mountain” or the “Company”), and Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), entered into a Common Stock Purchase Agreement (the “SPA”). Pursuant to the terms of the SPA, Lavazza has agreed to make a $250,000,000 investment (the “Investment”) in Green Mountain’s common stock, par value $0.10 per share (“Common Stock”), at a purchase price per share equal to the volume-weighted average price of the Common Stock for the 60 trading days before the closing of the Investment, less 7.5% (the “Shares”). [Bold and italicized emphasis added.]

Thus, Lavazza's "purchase price per share would be equal to the volume-weighted average price of the Common Stock for the 60 trading days before September 28, 2010, less 7.5% (the “Shares”).” If the share price were to have dropped prior to Sept. 28, it would be reflected in Lavazza's final purchase price.

Based on the agreed upon terms, Luigi Lavazza paid $250 million to purchase 8,566,649 shares, or an average price per share of $29.18 which was computed as follows:

$31.55 gross volume-weighted average price of the Common Stock less 7.5% discount or $2.37 equals $29.18.

On September 28, 2010, Green Mountain closed its Common Stock Purchase Agreement with Luigi Lavazza. Later that same day, after the stock market closed, the company finally disclosed the SEC inquiry and the discovery of the margin error to investors.

On September 29, 2010, Green Mountain stock dropped $5.95 per share to close at $31.06 per share, a 16.1% drop in market value that day in reaction to news of the SEC inquiry and accounting error. The stock continued to drop to $26.87 per share on October 11, 2010.

Green Mountain’s gross "volume-weighted average price" per share of stock in the sixty trading days prior to closing its Common Stock Purchase Agreement with Luigi Lavazza was about $31.55 per share. Apparently, if Green Mountain had waited to close the deal until after it disclosed news of the SEC inquiry and margin error, Luigi Lavazza would have paid less money per share to the company. This leads to the question: did Green Mountain purposely delay disclosure to investors of the SEC inquiry, the margin error, significant weaknesses in internal controls, and possible breaches of representations and warranties under its agreement with Luigi Lavazza?

Or did Green Mountain give early warning to Luigi Lavazza under the terms of their confidential agreement? (See Common Stock Purchase Agreement Section 7). In such case, did Luigi Lavazza not care about the probable negative impact on the stock price after the SEC inquiry and margin errors were disclosed to investors? And if so, why not?

More accounting errors discovered

On November 19, 2010, Green Mountain filed an 8-K report updating investors about the margin error it disclosed on September 28, 2010 and also disclosed additional accounting errors:

["Margin error"] A $7.6 million overstatement of pre-tax income, cumulative over the restated periods, due to the K-Cup inventory adjustment error previously reported in the Company’s Form 8-K filed on September 28, 2010. This error is the result of applying an incorrect standard cost to intercompany K-Cup inventory balances in consolidation. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. Rather than correcting the cumulative amount of the error in the quarter ended September 25, 2010, as disclosed in the September 28, 2010 Form 8-K, the effect of this error will be recorded in the applicable restated periods.

A $1.4 million overstatement of pre-tax income, cumulative over the restated periods, due to the under-accrual of certain marketing and customer incentive program expenses. The Company also has corrected the classification of certain of these amounts as reductions to net sales instead of selling and operating expenses. These programs include, but are not limited to, brewer mark-down support and funds for promotional and marketing activities. Management has determined that miscommunication between the sales and accounting departments resulted in expenses for certain of these programs being recorded in the wrong fiscal periods.

A $1.0 million overstatement of pre-tax income, cumulative over the restated periods, due to changes in the timing and classification of the Company’s historical revenue recognition of royalties from third party licensed roasters. Because royalties were recognized upon shipment of K-Cups by roasters pursuant to the terms and conditions of the licensing agreements with these roasters, Keurig historically recognized these royalties at the time Keurig purchased the K-Cups from the licensed roasters and classified this royalty in net sales. Management has determined to recognize this royalty as a reduction to the carrying cost of the related inventory. The gross margin benefit of the royalty will then be realized upon the ultimate sale of the product to a third party customer. Due to the Company’s completed and, when consummated, pending acquisitions of third party licensed roasters, these purchases and the associated royalties have become less of a factor, since the post-acquisition royalties from these wholly-owned roasters are not included in the Company’s consolidated financial statements.

An $800,000 overstatement of pre-tax income, cumulative over the restated periods, due to applying an incorrect standard cost to intercompany brewer inventory balances in consolidation. This error was identified during the preparation of the fiscal year 2010 financial statements and resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales.

A $700,000 understatement of pre-tax income for the Specialty Coffee business unit, due primarily to a failure to reverse an accrual related to certain customer incentive programs in the second fiscal quarter of 2010. The over-accrual was not identified and corrected until the fourth fiscal quarter of 2010.

In addition to the errors described above, the Company also will include in the restated financial statements certain other immaterial errors, including previously unrecorded immaterial adjustments identified in audits of prior years’ financial statements. [Bold and italicized emphasis added.]

Green Mountain also claimed that:

… these errors were discovered by management during the course of its preparation of the year-end financial statements and audit, as well as during the course of an internal investigation initiated by the audit committee of the Company’s board of directors in light of the previously disclosed inquiry by the staff of the Securities and Exchange Commission’s (“SEC”) Division of Enforcement. [Bold and italicized emphasis added.]

In its September 28, 2010 8-K report, Green Mountain claimed that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter.” Presumably, the additional errors listed in the November 19, 2010 8-K report were discovered during the internal investigation after the SEC notified the company of it informal inquiry.

We still don’t know exactly when Green Mountain discovered the margin error, whether it was before or after the company learned about the SEC inquiry on September 20, 2010. However, we now know that Green Mountain found several new accounting errors about sixty days after it was notified of the SEC inquiry. It also appears that Green Mountain is taking the position that its errors were "immaterial."

Materiality of accounting errors

Originally on September 28, 2010, Green Mountain disclosed that it overstated pre-tax income from 2007 to 2010 because of the margin error. The company claimed that the margin error was “immaterial” and said it would correct that error by making a cumulative adjustment to earnings “in the quarter ended September 25, 2010.”

On November 19, 2010, Green Mountain disclosed three new overstatements totaling $3.2 million pre-tax income and one new understatement of $0.7 million in pre-tax income, making a total overstatement of $10.1 million in pre-tax income. This time, the company announced that it would restate its financial reports issued from 2007 to 2010 to correct all of its errors:

On November 15, 2010, the board of directors of Green Mountain Coffee Roasters, Inc. (the “Company”), based on the recommendation of the audit committee and in consultation with management, concluded that, because of errors identified in the Company’s previously issued financial statements for the fiscal years ended September 29, 2007, September 27, 2008 and September 26, 2009 and the first three fiscal quarters of 2010, the Company will restate its previously issued financial statements, including the quarterly data for fiscal years 2009 and 2010 and its selected financial data for the relevant periods. Accordingly, investors should no longer rely upon the Company’s previously released financial statements for these periods and any earnings releases or other communications relating to these periods. [Bold and italicized emphasis added.]

Green Mountain did not identify any specific accounting error as "material." However, under SEC Staff Accounting Bulletin No. 99, accounting errors are material when they cause the "financial statements taken as a whole" to be "materially misstated" or "materially misleading." Such errors must be corrected by restating financial reports, instead of using a cumulative adjustment to the latest quarter's report to correct those errors.

How Green Mountain tried to spin the materiality issue

In its November 19, 2010 8-K report, Green Mountain tried to minimize to seriousness of its accounting errors by using carefully crafted language claiming that:

The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements.

The adjustments necessary to correct the errors will have no effect on reported cash flow from operations, and are not expected to have a material impact on the balance sheet.

Such errors can still be cause "financial statements taken as a whole" to be "materially misstated" or "materially misleading." SAB No. 99 directly addresses that issue:

If the misstatement of an individual amount causes the financial statements as a whole to be materially misstated, that effect cannot be eliminated by other misstatements whose effect may be to diminish the impact of the misstatement on other financial statement items. To take an obvious example, if a registrant's revenues are a material financial statement item and if they are materially overstated, the financial statements taken as a whole will be materially misleading even if the effect on earnings is completely offset by an equivalent overstatement of expenses.

Even though a misstatement of an individual amount may not cause the financial statements taken as a whole to be materially misstated, it may nonetheless, when aggregated with other misstatements, render the financial statements taken as a whole to be materially misleading. [Bold and italicized emphasis added.] 

For example, Company A and Company B are both competitors and each company has $100 of revenue, $100 of expenses, and zero profits. Both companies make only cash sales to customers and pay all of their expenses in cash. Each company started and ended the year with $100 in cash because they had zero profits.

Company A wants to make it appear that it has more market share (revenues) than company B and it inflates revenues and expenses by $100 each to report $200 of revenues, $200 of expenses, and but still zero profits. At the end of the year both companies report zero profits, zero cash flows from operations, and $100 cash on their balance sheets.

Company A's inflation of revenues and expenses did not change its reported profits, cash flow from operations, or balance sheet. However, Company A materially overstated both its revenues and expenses. Therefore, Company A's financial statements "taken as a whole" were "materially misleading."

Green Mountain said that "The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements." However, Green Mountain made no specific mention that its "financial statements taken as a whole" were "materially misstated" or "materially misleading."

Green Mountain should explain its decision to consider the margin error as an "immaterial accounting error"

When Green Mountain issues its restated financial reports, it should provide a thorough analysis and explain to investors why, originally on September 28, 2010, it considered the margin error “immaterial” and initially decided to use a cumulative adjustment to Q4 2010’s financial report to correct that error instead of restating its financial reports.

When the SEC Division of Corporation Finance conducts periodic reviews of public company financial reports and finds accounting errors, it requires the companies to provide a detailed materiality analysis using criteria under SAB No. 99. The analysis is later made publicly available in company filings after the review is completed. At the very least, Green Mountain should provide this analysis to investors when it files its 2010 annual 10-K report.

According to SAB No. 99:

Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are –  

• whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate 
• whether the misstatement masks a change in earnings or other trends   
• whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise   
• whether the misstatement changes a loss into income or vice versa  
• whether the misstatement concerns a segment or other portion of the registrant's business that has been identified as playing a significant role in the registrant's operations or profitability  
• whether the misstatement affects the registrant's compliance with regulatory requirements
• whether the misstatement affects the registrant's compliance with loan covenants or other contractual requirements   
• whether the misstatement has the effect of increasing management's compensation – for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation 
• whether the misstatement involves concealment of an unlawful transaction. 

This is not an exhaustive list of the circumstances that may affect the materiality of a quantitatively small misstatement. Among other factors, the demonstrated volatility of the price of a registrant's securities in response to certain types of disclosures may provide guidance as to whether investors regard quantitatively small misstatements as material. Consideration of potential market reaction to disclosure of a misstatement is by itself "too blunt an instrument to be depended on" in considering whether a fact is material. When, however, management or the independent auditor expects (based, for example, on a pattern of market performance) that a known misstatement may result in a significant positive or negative market reaction, that expected reaction should be taken into account when considering whether a misstatement is material.

If Green Mountain's margin error fell under any of the criteria listed above, it should have been considered a material accounting error under SAB No. 99, rather than an "immaterial accounting error" as originally claimed by the company.

Insider sales of stock

In a previous blog post, I detailed how on September 21, 2010, a day after Green Mountain was notified of the SEC inquiry, but seven days before the SEC inquiry was disclosed to investors, executive officer Michelle Stacy exercised 5,000 options and immediately sold her shares at $37 per share. At that time, Michelle Stacy's Form 4 disclosure did not reflect that she sold her shares pursuant to a Rule 10b5-1 trading plan. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold.

About five weeks after that blog post, on October 28, 2010, Stacy belatedly filed an amended Form 4 report and disclosed that:

This Form 4 has been amended to note that these sales were affected pursuant to a Rule 10b5-1 trading plan adopted by Ms. Stacy on 08/13/2010. 

In addition, Michelle Stacy filed another amended Form 4 report to reflect that her September 13, 2010 option exercise and sale of stock was also "affected pursuant to a Rule 10b5-1 trading plan." That option exercise and sale took place just seven days before Green Mountain was notified by the SEC on an inquiry.

At the very least, Michelle Stacy’s filing of amended Form 4 reports displays a continuous pattern of problematic financial reporting by Green Mountain and its officers and which increases investor uncertainty about the integrity of the company’s SEC filings.

Many responsible companies voluntarily disclose their insider's 10b5-1 trading plans as they are adopted, even though such disclosure is not required under existing SEC rules. The existence of 10b5-1 trading plans are only required to be disclosed on Form 4 as insiders purchase or sell their stock pursuant to such plans. However, voluntary disclosure at the inception of a 10b5-1 trading plan by insiders increases corporate transparency.

On August 13, 2010, Michelle Stacy exercised 30,000 options and immediately sold her shares at $30.95 per share. Not till October 28 did Stacy file amended Form 4 reports to reflect that her September 13th and 21st option exercises and sales of stock were carried out pursuant to a Rule 10b5-1 trading plan. Stacy claimed that she adopted a 10b5-1 trading plan on August 13. On August 13th, Stacy exercised options and sold stock, but she still does not claim that those transactions were made pursuant to a 10b5-1 trading plan.

If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations. If it turns out that Michelle Stacy had non-public knowledge of any of those issues affecting Green Mountain before adopting her 10b5-1 trading plan, she could be charged by the SEC with alleged insider trading violations. Several lawsuits seeking class action status have already alleged securities law violations by Green Mountain and its officers.

Usually 10b5-1 trading plans call for the purchase or sale of stock by insiders at regular intervals.  Michelle Stacy’s plan doesn't appear particularly regular. On Monday, September 13, 2010, she exercised options and sold 5,000 shares of Green Mountain stock. Eight days later on Tuesday, September 21, 2010 (and a day after Green Mountain received notification of the SEC inquiry) she exercised options and sold another 5,000 shares of Green Mountain stock. Forty-five days later, on November 5, 2010, Michelle Stacy exercised options and sold 10,000 shares of Green Mountain stock. In the interest of transparency, Michelle Stacy should explain how the timing of option exercises and sales were determined under her 10b5-1 plan.

PricewaterhouseCoopers

PricewaterhouseCoopers is Green Mountain’s current auditor and it is now evident that it missed a growing list of accounting errors covering fiscal years 2007 to 2010. Likewise, until 2009 PricewaterhouseCoopers was Overstock.com’s (NASDAQ: OSTK) auditors, too. Every single initial financial report issued by Overstock.com from 1999 to 2009 had to be restated at least once and as many as three times due to accounting errors. Therefore, PricewaterhouseCoopers missed accounting errors by Overstock.com in each and every audit it performed of the company.

In 2009, I identified certain violations of Generally Accepted Accounting Principles (GAAP) which ultimately caused Overstock.com to restate its financial reports for the third time in three years, after the SEC intervened and forced to company to correct its accounting errors. During the ongoing SEC investigation, PricewaterhouseCoopers defended Overstock.com’s improper accounting treatment of cost recoveries from vendors and as it turns out, they were wrong.

Prematurely proclaiming the absence of wrongdoing 

In its November 19, 2010 8-K report, Green Mountain claimed that none of the financial statement errors implicate misconduct with respect to the Company or its management or employees:

The internal investigation is nearly complete, and the Company continues to cooperate fully with the SEC. None of the financial statement errors implicate misconduct with respect to the Company or its management or employees. In addition, none of the financial statement errors are related to the Company’s relationship with M.Block & Sons, the fulfillment vendor through which the Company makes a majority of the at-home orders for the Keurig business unit’s single-cup business sold to retailers. [Bold and italicized emphasis added.]

It is premature for Green Mountain to proclaim the absence of any wrongdoing while the SEC inquiry is still ongoing and it admits that its own internal investigation is not fully completed. The SEC inquiry began on September 20 and has not been concluded. That statement will come back to haunt Green Mountain if the SEC decides to conduct a formal investigation.

In any case, I am naturally suspicious of self-proclaimed absences of wrongdoing without thorough outside independent examination. Back in the old days at Crazy Eddie, we conducted a similar internal inquiry with help from our auditors into certain allegations of wrongdoing involving a supplier and proclaimed ourselves clean. The auditors falsely claimed to both our audit committee and the SEC that they thoroughly checked out those allegations and found no wrongdoing. Management and auditors have little incentive to report their own foul-ups.

Final comment

Every financial report issued by Green Mountain and certified by PricewaterhouseCoopers from 2007 to 2010 had to be restated because of accounting errors. In addition, Green Mountain CEO Lawrence J. Blanford and CFO Frances G. Rathke signed Sarbanes-Oxley certifications covering those reports. So far no one has been held accountable by Green Mountain for its financial misstatements – not its auditors, CFO, or CEO.

While I personally like the smell of Green Mountain's coffee, I don't like the smell of its financial disclosures. A little more enthusiasm in cleaning up its financial reporting (like it devotes to cleaning up the environment) and a little more transparency would go a long way.

Written by,

Sam E. Antar (with research assistance from Ilene)

Recommended reading about issues with 10b5-1 trading plans

February 1, 2009: Stanford University Graduate School of Business - Sec Rule 10b5-1 and Insiders' Strategic Trade by Alan D. Jagolinzer

July 2009: Stanford University Graduate School of Business - Research Underpins SEC Scrutiny of Scheduled Insider Trades by Bill Snyder

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. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

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.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of those companies is a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

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.