White Collar Fraud

Why Abolishing or Weakening Sarbanes-Oxley is Insane! Lessons from the Crazy Eddie Fraud

2009-11-07T00:08:00.013-05:00

A message to any Democrat, Republican, or Independent lawmaker who is thinking of abolishing or weakening the Sarbanes-Oxley Act of 2002. As a convicted felon, who committed his crimes in cold blood and with callous disregard for my victims, I will publicly endorse each and every one of you as a champion of the white collar criminal class that are a cancer on the integrity of our great capitalist economic system. If you abolish or weaken Sarbanes-Oxley, you will make it much easier for corporate white collar criminals to cook their books and defraud investors.

According to Floyd Norris's column in the New York Times column:

The House Financial Services Committee this week approved an amendment to the Investor Protection Act of 2009 — a name George Orwell would appreciate — to allow most companies to never comply with the law, and mandating a study to see whether it would be a good idea to exempt additional ones as well.

In a new series of blog posts over the next few months, I will document why Sarbanes-Oxley should be strengthened with added reforms to protect the integrity of our capital markets. For starters, please read the letter below that I submitted to the SEC and PCAOB Roundtable on Internal Control Reporting Requirements in 2006.

Respectfully,

Sam E. Antar (a convicted felon and former Crazy Eddie CFO)

The Implications of the Crazy Eddie Fraud for 21st Century Auditing Practices

April 28, 2006

Nancy M. Morris
Secretary
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20649-1090

Re: SEC and PCAOB Roundtable on Internal Control Reporting Requirements

Rule Comments File Number 4-511

The Implications of the Crazy Eddie Fraud for 21st Century Auditing Practices

I am the former Chief Financial Officer of Crazy Eddie, Inc., a now-defunct chain of consumer electronics stores in New York and New Jersey whose common stock began publicly trading in September 1984. Along with my cousin Eddie Antar, his father Sam M. Antar, and other members of Eddie's immediate family, I helped to mastermind one of the largest securities frauds perpetrated in the 1980's. The notoriety of this case has continued into the 21st century. "Crazy" Eddie Antar, dubbed the "Darth Vader of Capitalism" by the then-United States Attorney Michael Chertoff (now the Secretary of Homeland Security), has left a legacy of fraud that has important implications for today's auditing practices.

The Crazy Eddie fraud and others like it were prime reasons for later reforms like Sarbanes Oxley, the formation of the Public Company Accounting Oversight Board (PCAOB) and stricter auditing standards in general. The brazen and unprecedented methods used in the Crazy Eddie fraud to subvert standard auditing procedures are still instructional today and should be considered in the context of recent reforms.

My employment at Crazy Eddie began in 1971 at the age of 14, when I was hired by Eddie Antar as a janitor and stock boy in one of the stores. From its inception, Crazy Eddie ran a cash-based business, and my starting salary was $10 a day off the books. I was interested in numbers and statistics from a young age and was an avid reader of the Wall Street Journal and Barron's from the age of 13. Hoping to keep all aspects of the Crazy Eddie business within the Antar family, which was very tightly knit, Eddie paid my way through college with a view of making me the "numbers man" of the operation.

With a degree in accounting from Bernard Baruch College, I passed the CPA exam in the top 98th percentile in 1980. While I was in college, Crazy Eddie retained a small accounting firm to audit its books and records, and was the firm's largest client. To complete the two year audit experience requirement for my CPA license, I went to work for this firm from 1981 to 1983, while continuing to work part-time at Crazy Eddie, where I helped to skim cash sales receipts, particularly during the busy holiday season. Through my position at the accounting firm, I had access to the audit work papers for the Crazy Eddie audits.

The culture of tax evasion was prevalent from the onset at Crazy Eddie. Our philosophy was that the government was not entitled to any taxes that we could hide from it. The family's choice to hire a small accounting firm to audit the company's records was motivated by the fact that Crazy Eddie was engaged in a massive skimming fraud. We also perpetrated other forms of tax evasion, consumer fraud, and insurance fraud.

From 1979 to 1984, Crazy Eddie gradually reduced its skimming each year to create artificial profit growth in the years prior to its initial public offering. It in effect created a fraud by "going legitimate." I was learning from our own accounting firm the methods by which our records were audited and reporting this information back to the family so as to better subvert our auditors.

By 1984, Crazy Eddie had gone public and had hired the ninth largest accounting firm in the world to audit its records. We chose this firm because the company almost completely lacked internal controls and had no chief financial officer. My father, Eddy Antar, who had a high school education, was the Treasurer. Despite an article published in Barron's criticizing the company, Crazy Eddie went public and became the darling of Wall Street. The company's $40 million capitalization at the time of the initial public offering grew to a $600 million market capitalization, built completely on fraud.

I received my CPA license in 1985 and became the Controller of Crazy Eddie that same year. In 1986, I was appointed Chief Financial Officer.

As a public company, we overstated our profits (rather than understate them as a private company so as to underpay taxes), to increase our reported earnings to shareholders and inflate the market price of Crazy Eddie stock. Eddie, Sam M. Antar, and other family members sold over $100 million dollars in inflated and worthless stock. I never made a profit selling Crazy Eddie stock.

During the period from 1984 to 1987, we overstated the values of our inventories, understated how much money we owed our creditors and even put some of the previously skimmed money back into the company to overstate the earnings of Crazy Eddie. We committed a host of other frauds too numerous to list here as well.

The auditors failed to do fundamental audit work which would have uncovered at least some of the fraud, such as sales cut off testing, aging accounts payable and adequate substantive testing. In the last two years (1986 & 1987) under Antar family control, the auditors failed to be present at all of the inventory locations, leaving Crazy Eddie employees alone to take inventories at year end for many of the store inventory locations. In the last year of the audit, they left the key to the supposedly secure audit work in a paper clip box on an office desk at Crazy Eddie premises at night.

Sarbanes Oxley

Many accounting firms have lobbied claiming that consulting services help them understand their clients better. My experience from Crazy Eddie has shown me that this was simply untrue, since both accounting firms that used to audit the company provided consulting services far in excess of their audit work. In fact during the last two years of the Crazy Eddie fraud, when the largest part of the fraud was perpetrated, in terms of overstatements of earnings, the large accounting firm had consulting personnel at Crazy Eddie almost every day.

There have been people advocating exempting or relaxing Sarbanes Oxley regulations for companies with small market capitalizations (under $125 million). As stated previously, Crazy Eddie went public with a market capitalization of $40 million (already built on a skimming fraud) and its market capitalization eventually rose to over $600 million in less than two years. Therefore, Crazy Eddie would have been subject to the SOX exemption when it went public.

Sarbanes Oxley - Review of Internal Controls

Many critics of SOX have argued that internal controls are too costly for small companies. The auditors of Crazy Eddie tried to remedy the situation by doing a so called "substantive audit" with no reliance on internal controls since the company's internal controls were very poor. While in theory you can conduct an audit without reliance on internal controls, the absence of adequate internal controls poses the problem of making almost all companies difficult or virtually impossible to audit. Therefore, the review of internal controls of a company by independent outside auditors is crucial for effective auditing. It is evident that a company must have a viable system of internal controls to be auditable. Both items are not mutually exclusive.

In many instances I found that the size of the accounting firm had no bearing on their ability to conduct an audit. The accounting firm that ranked number 9 in the world and audited Crazy Eddie from 1984 to 1986 merged into a "Big Eight" firm in 1987 (a ‘big four" firm now) the last year of our fraud. Ultimately, the Crazy Eddie fraud was not uncovered by the company's auditors but as a result of informants due to family infighting.

Auditors' Lack of Investigative Skills

I found that the auditors of our accounting firms in many cases did not know how to ask the right questions. When they did ask the right questions, they did not know how to formulate the proper follow up questions and were often too trusting of the answers they received. Many of the auditors were not educated or trained well enough for their assignments. In point of fact, accounting students are not trained to conduct field interviews in college and there are no prerequisites for interviewing skills or education level to obtain a CPA license.

As a CPA, I used my familiarity with accounting practices to outwit and mislead the auditors. I also counted on the weakness of human nature. Auditors do not want to believe their client is committing a crime.

For example when we had converted our "off the books" payroll to a fully "on the books" payroll prior to our initial public offering, the auditors noticed many people who had been working for only $5,200 per year now being paid $52,000 or more per year. They simply accepted our explanation of the sacrifice and dedication of these employees, due to their investment in the future growth of a growing public company.

In 1987 I simply changed two words in the footnotes of our disclosure regarding the treatment of trade discounts and allowances to being recognized "when earned" rather than "when received", making them accounted for on a cash basis. I had discussed this change with the auditors but there was no accounting change adjustment as required under generally accepted accounting principles (GAAP). The Wall Street analysts and the investing public did not notice required accounting adjustment under GAAP.

Auditors' Inexperience

I found that in many cases, auditors lacked the experience to handle their field assignments. For example, the person who handled most of the auditing for Crazy Eddie's accounts payable in 1987 had only six months' experience in accounts payable and finished his work after the audit was signed off. The auditor found major discrepancies in these records (which were later found to be fraudulent in the SEC and FBI investigation), but never investigated them during the audit. As a result, Crazy Eddie's accounts payable was understated by 40% that year.

Accounting Education

Even today there are many complaints by companies and critics of Sarbanes Oxley relating to the auditors review of internal controls in that they are merely filling in boxes in their work papers. Like the auditors of Crazy Eddie, today's auditors have not been adequately prepared for conducting these reviews.

The solution is very fundamental. It is about education. Competence cannot be legislated, though it can be learned. Sarbanes Oxley, the PCAOB and new accounting regulations instituted by the American Institute of Certified Public Accountants (AICPA) (SAS Number 99, for example) have placed much emphasis on internal controls and detecting fraud. A significant majority of accounting students still do not take a single dedicated college level course to gain a complete understanding of these new requirements. They are often simply learned as part of a general auditing course and are covered within a day or two of the semester.

Legislation such as Sarbanes Oxley cannot be effective unless it is properly incorporated into the education of accounting students. As the future auditors of modern businesses, these students simply do not have enough education on issues such as white collar fraud, internal controls, securities laws, accounting standards, and auditing standards and techniques.

Most accounting students do not take a single college level course on white collar fraud, internal controls, securities law, insurance, sureties, estates, etc. In fact, many of the subjects that are tested on the CPA exam are not covered in college. They must "learn" these subject areas in a CPA exam (cram) review course after they graduate.

Criminology and criminal psychology courses are almost nonexistent within the context of an accounting education. A minority of universities and colleges offer a specific white collar fraud class today and most of those schools offer it as an elective course. Students are not even taught how to ask proper questions or conduct field interviews. Criminology and interview skills are not covered on the CPA exam. How can the auditors expect to match the wits of criminals who actively engage in committing white collar fraud?

The lack of education on these substantive issues is all the more disturbing given that the required amount of credits to receive a CPA has since been increased from 120 credits to 150 credits. The requirements for passing the CPA exam have also been relaxed in many states.

The AICPA only "suggests" that CPAs take 10% of their mandatory continuing education credits in fraud related areas without making distinctions pertaining to an accountant's main areas of work.

In sum, the profession is not adequately educated, trained, and skilled to deal with individuals who are intent on evading the law. I strongly suggest that the SEC and the PCAOB establish higher minimum education, skills, and training standards for accountants who conduct public company audits and evaluate such internal controls. In addition I strongly suggest that the AICPA establish higher minimum education, skills, and training standards for accountants who conduct private company audits and evaluate such internal controls.

The system for educating our future CPAs must be reformed and upgraded or the new reforms such as Sarbanes Oxley will be of very limited value. The college curriculums and continuing education standards must be improved.

In the CPA Letter, published by the AICPA, in January 2003 an article said, "Sam Antar, a former CPA with the now-defunct Crazy Eddie's electronics chain, would be the first to agree that CPAs need to learn more about fraud. That's because Antar, now a convicted felon, helped engineer a half-billion dollar financial statement fraud that was made possible by taking advantage of the company's independent auditors."

With the requirements of Sarbanes Oxley and new auditing standards such as SAS Number 99 and the lack of corresponding education, training and skills for our accountants, professionals are being sent into the field without being properly equipped to implement these standards.

Today, there has been a multitude of company restatements of financial reports, the PCAOB has reported too many issues relating to weaknesses in its review of audits conducted by many accounting firms, and far too many frauds are uncovered years after the fact, once significant damage has been done. This evidence casts a poor reflection on both company professional accounting staff (since many internal accountants go through the same education curriculums as CPAs and are CPAs) and external auditors and signifies a lack of proper education, training, skills, and internal controls.

Auditor Independence, Criminal Psychology, and Audit Costs

Today, the Crazy Eddie fraud is referenced is many publications, textbooks and theses and is also included in many university curriculums. Many people have wondered whether the long enduring success of the Crazy Eddie fraud was due to the criminal subversion of the Antar family or the incompetence of the auditors involved. People have also speculated as to whether the independence of the auditors was impaired because of the extensive consulting work that Crazy Eddie gave them, which served as a significant source of revenues.

I have many answers. With regards to the small firm we used for many years my cousin Eddie always liked the fact that he was their biggest client of which they derived significant revenues as a means of deriving indirect undue influence. Regarding both the small and large accounting firms, as criminals taking advantage of human nature we believed our largess made them less likely to ask the tough questions. Maybe they were embarrassed or maybe their economic self interest of losing high paying consulting agreements played a role. Instead did they not have the education, training, and skills I am advocating or were they plain stupid?

What is known is that it was common practice in the profession at the time to "loss leader" the audits fees, or have low margins of income on these fees and make it up with other business. Perhaps this is one unspoken reason today (in addition to litigation costs absorbed by accounting firms) why auditing fees have escalated as they have.

Understanding White Collar Fraud, Criminality, Consulting Work

I also knew that the lack of basic education on the part of the auditors, regardless of how much consulting work they did with the aim of "knowing the client", would make them essentially incapable of detecting the fraudulent techniques that we employed. They knew nothing about criminology. They could not fathom that their clients were committing frauds.

They ignored signs like insiders selling their stocks at almost every opportunity and the outlandish answers they received to their infrequent good questions which were never followed up.

Preventing White Collar Fraud

Recently, many white collar criminals have received very stiff sentences, which I firmly support. However, this is not a material deterrent to crime, but rather a society's policy for dealing with the consequences of those found guilty of it. A substantial majority of white collar crimes are committed by people without prior criminal records.

Since being released from prison, Barry Minkow (ZZZZ Best Fraud), now a pastor, respected community leader, author, and private investigator, has helped the government uncover billions of dollars in fraud. He was once aptly quoted in The Guardian on July 11, 2002 as saying, "Everyone I met in prison had one thing in common - they never planned on being there."

White collar crime will continue to be a fact of society. It is only a matter of how often these crimes will be brought to justice based on the diligence of those who are properly trained. It will be either more noticed or less noticed.

Crazy Eddie was not the exception to the rule, but, rather, a small case, although highly sensationalized for the time, relative to today's fraud headliners such as Enron, WorldCom, Tyco, and others. This is only proof that the lessons demonstrated during a time when fraud occurred on a much smaller scale still have not been inculcated. My lack of prior criminal engagement is also not exceptional since over 88% of white collar fraud is committed by people without prior criminal records. Do students or audit staffs know this?

To deter this form of crime, companies need to build better barriers through strong internal controls. We require an accounting profession with a higher level of education, training and skills that is strongly independent from its clients.

We need the implementation of laws like Sarbanes Oxley. Better internal controls for corporations, are not just a means of combating fraud but are a matter of good business practices in general.

According to an article published in the New York Times on December 3, 2005,"For all its cost, Sarbanes law is working," by Joseph Nocera:

John J. Mahoney, the chief financial officer at Staples, which has a market cap in excess of $16 billion, has spent $7 million to $10 million instituting Sarbanes-Oxley. "But it's been worth it. It has offered us an opportunity to look at our processes, and in many cases to improve them," he said. "We found that our people really benefited from the processes." He concluded: "It has made Staples a better company."

One simple lesson from the Crazy Eddie fraud that can be learned is that companies who get capital from the public markets (public companies) have a sacred fiduciary duty to their investors and creditors to have strong internal controls that are verifiable and reviewed by well qualified, truly independent auditors. Private companies, too, owe the same duty to their creditors and shareholders.

Strong internal controls, auditor independence, accounting education, and the integrity of financial reporting are the four main pillars to the soundness of our financial reporting system. They must all work in conjunction for accounting standards to be properly implemented.

Importance of Integrity of Financial Information to Survival of our Capitalist Free Market Economic System

The main pillar of our capitalistic free market economic system, which is a cornerstone of democracy, is the integrity of financial information. Without reliable financial information, capitalism cannot and will not survive. However, the integrity of financial information can only be achieved through building blocks such as sound internal controls and independently verifiable financial information. The well educated, skilled, and experienced accountant is the first line of defense for the capitalist system.

Sarbanes Oxley is the Beginning of the Solution

Sarbanes Oxley should only be considered a first step in a much more complex process towards improving a system of internal controls and, by default, the integrity of financial reporting. Let us start the process of making stronger the corporations, which is at the heart of our economic system.

Respectfully submitted,

Sam E. Antar
Former Crazy Eddie Chief Financial Officer

Other information:

List of all blog posts (in date order)

Media commentary and mentions (in date order)

What is Patrick M. Byrne Afraid Of?

2009-11-04T02:49:00.008-05:00

Patrick Byrne is afraid to answer questions about Overstock.com's (NASDAQ: OSTK) continuous violations of Generally Accepted Accounting Principles (GAAP) and SEC disclosure rules. Because of those violations, Overstock.com's current financial reports cannot be accurately compared to reports in corresponding prior periods.

In its latest Q3 2009 financial report Overstock.com disclosed a new inquiry by SEC’s Division of Corporation Finance regarding its 2008 Form 10-K/A (amended 10-K report) and its June 30, 2009 Form 10-Q. The company did not disclose the nature of that inquiry.

The SEC Enforcement Division recently re-opened its investigation into financial reporting violations at Overstock.com, fifteen months after it closed a previous probe of the company. After the SEC closed that probe, Overstock.com restated its financial reports for the second time in three years due to GAAP violations. The SEC re-opened its probe of Overstock.com in response to a series of investigative reports by this blog documenting how Overstock.com improperly used a "cookie jar" reserve to materially inflate future earnings or reduce future losses (details here).

Now Overstock.com faces two parallel probes by the SEC. The Enforcement Division is investigating Overstock.com's financial reporting over the last several years and the Division of Corporation Finance is reviewing more recent financial reports.

In Q3 2009, Overstock.com did not restate its previous comparable financial reports to correct its GAAP violations. Instead, CEO Patrick Byrne seems intent on toughing it out with the SEC and forcing it to take enforcement action against the company to comply with GAAP (details here).

I sent Patrick Byrne an email and asked to participate in Overstock.com’s Q3 2009 earnings call, so I could ask questions about Overstock.com's violations of GAAP and other SEC disclosure rules. In response, Patrick Byrne responded with an angry anti-Semitic diatribe, called me a “gonif” (Hebrew/Yiddish word for thief), and posted my email on his Deep Capture blog, despite previous claims that his Deep Capture is unrelated to Overstock.com.

Investigative journalist and best-selling author Gary Weiss summed it up in his blog:

So Byrne immediately went berserk on his Deep Capture smear site, posting Sam's email and a sneering, Jew-baiting response denying the request, saying that Sam could only ask four questions of up to 25 words, sent in advance via email.

This happened shortly before dawn Utah time. That assumes Byrne actually is in Utah, where he makes believe he runs the company, and not in New York, preparing to march in the Halloween Parade, perhaps disguised as a law-abiding corporate executive.

Byrne has every reason to be terrified of Sam, and to go off his nut whenever he hears from him. After all, if it wasn't for Sam, he wouldn't be under a newly reopened SEC investigation.

But evidently Byrne forgot that he has repeatedly argued that Deep Capture has "nothing to do with Overstock," even though he founded it, funds it, it focuses on trashing the company's critics, and it runs on Overstock's Internet servers. Sam's email had nothing to do with Byrne's pet "naked short selling" cause.

In any case, I submitted my questions via email, posted them in my blog, posted them in the comments section of Byrne’s Deep Capture blog, and called into the conference call. Patrick Byrne did not answer any one of my emailed questions and did not allow me to ask questions during the call, despite being alerted by the operator that I was on the line. However, Patrick Byrne did respond to some softball questions from an analyst who participated in the call and even took emailed softball questions from others.

Why is he afraid to address questions about GAAP and other financial reporting violations by his company?

Over the last two years, my blog has documented continuous pattern of deceitful, inconsistent, and contradictory statements made by Patrick Byrne and Overstock.com’s management that more often than not conflicted with other disclosures made by them and Overstock.com. Since its inception, every single financial report issued by Overstock.com has initially violated GAAP or some other SEC disclosure rule. See details here.

Before I continue let’s review some history, below:

A history of violating GAAP and SEC disclosure rules

In February 2006, Overstock.com restated its financial reports from Q1 2002 to Q3 2005 due to inventory accounting errors.

From Q2 2007 to Q2 2008, Overstock.com violated SEC Regulation G governing non-GAAP financial measures such as EBITDA and materially inflated its financial performance. My blog documented how Overstock.com improperly reconciled its reported EBITDA to net income, rather than operating income, and it improperly eliminated stock-based compensation costs from its EBITDA calculation (details here).

In January 2008, the Securities and Exchange Commission Division of Corporation Finance discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception (details here). In its correspondence with the SEC, I discovered that the company improperly provided the SEC with a flawed and misleading materiality analysis to convince regulators that its revenue accounting error was not material to avoid restating its financial reports (details here).

Instead of restating prior financial reports to correct its material revenue accounting error, Overstock.com improperly used a one-time cumulative adjustment in its Q4 2007 financial report to hide the material impact of such errors on prior reporting periods. In Q4 2007, Overstock.com’s one-time cumulative adjustment reduced revenues by $13.7 million and increased net losses by $2.1 million resulting from the one-time cumulative adjustment to correct its revenue accounting errors.

On October 24, 2008, Overstock.com disclosed new customer refund and credit errors and the company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com restated all financial reports dating back to 2003.

In addition, Overstock.com reversed its one-time cumulative adjustment in Q4 2007 that it previously used to improperly correct its revenue accounting errors. This time Overstock.com properly restated all previous financial statements to correct those errors revenue accounting errors, as I previously recommended.

In amended financial reports filed with the SEC in connection with its restatement, Overstock.com quietly revised its improper EBITDA measure and replaced it with “Adjusted EBITDA” without any explanation.

The company reported that the combined amount of revenue accounting errors (previously uncovered by the SEC) and newly disclosed customer refund and credit accounting errors resulted in a cumulative reduction in previously reported revenues of $12.9 million and an increase in previously reported accumulated losses of $10.3 million.

However, Overstock.com continued to violate GAAP in later accounting periods because did not include in its restatement a correction for offsetting costs and reimbursements earned from its fulfillment partners that resulted from the customer refund and credit errors reported in October 2008. Instead, Overstock.com falsely claimed that a “gain contingency” existed and improperly reported such income on a non-GAAP cash basis in future accounting periods In effect, Overstock.com improperly created a "cookie jar reserve" to inflate earnings in future reporting periods (details here).

Note: I recommend reading forensic accountant and author Tracy Coenen's blog on how cookie jar reserves work.

For example, the company should have reported a Q4 2008 loss, but instead reported a profit for that quarter by violating GAAP. That improperly reported net profit enabled Overstock.com to report its first quarterly profit after a string of 15 consecutive quarterly losses and beat mean analysts’ consensus expectations for earnings per share (See: SEC Staff Accounting Bulletin No. 99 about Materiality).

Therefore, single financial report issued by the company at least initially violated GAAP and SEC disclosure rules. Currently, the SEC is investigating whether Overstock.com should restate its financial reports for the third time in three years as a result of new GAAP violations exposed in my blog.

Why I asked my questions

Generally Accepted Accounting Principles are based on the principle of the comparability or being able to compare financial reports of a current reporting period against the same reporting period in a previous year. To properly achieve comparability, there must be a consistent application of accounting principles.

However, Overstock.com’s financial reporting is simply not comparable due to GAAP violations (described above) and other accounting tricks. Therefore, it is impossible to accurately compare Overstock.com’s financial reporting in any period to a previous comparable period. That’s why accounting errors are corrected by restating financial reports. According to the SEC, “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error.” (Source: Cease and Desist order issued “In the matter of Carl M. Apel”).

As I described above, in Q3 2008 Overstock.com reported that it underbilled its fulfillment partners offsetting costs and reimbursements arising from its customer refund and credit errors. It should have corrected all previously issued financial reports to include income already earned, but underbilled or still owed by its fulfillment partners, less a reasonable allowance for uncollectable amounts. For additional details see SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8, 22, and 23.

Instead, Overstock.com made up a phony “gain contingency” so it could improperly recognize such income as it was collected in future accounting periods and not when it was actually earned in prior accounting periods. Therefore, you have a distortion in Overstock.com’s financial reporting that makes it impossible to accurately compare financial reports in any period to a previous comparable period.

For example, Overstock.com claimed a net loss of $2.497 million for the nine months ended September 30, 2009. However, the company disclosed that it reduced its reported net losses by $1.7 million “due to recoveries from partners who were underbilled in 2008 for certain fees and charges, and for a refund of overbillings by a freight carrier for charges from the fourth quarter of 2008.” Therefore, if Overstock.com properly recognized such income when it was actually earned in prior reporting periods, its net loss would have been $4.197 million, instead of $2.497 million or nearly double the amount reported.

For the nine months ended September 30, 2008, Overstock.com claimed a net loss of $13.672 million. However, its net loss for that period improperly excluded an undetermined correction for income earned from offsetting costs and reimbursements that were not billed to its fulfillment partners.

Therefore, Overstock.com's net loss for the nine months ended September 30, 2008 was lower than reported by some indeterminable amount, while Overstock.com’s net loss for the following year period was higher by $1.7 million. We simply cannot accurately compare the current year's nine month reporting period to the previous year's nine month reporting period. Any claimed improvement by Overstock.com in its financial performance for the current nine month reporting period has to be much lower.

In Q3 2009, Overstock.com claimed reported a net loss of $0.787 million compared to a net loss of $1.589 million during Q3 2008 or an $800,000 reduction in net losses. However, $700,000 of the $800,000 disappears because Overstock.com received $700,000 “from an insurer in the settlement of a dispute regarding insurance coverage of a legal matter.”

In Q3 2008, we do not know how much income Overstock.com would have reported if the company properly made corrections for income earned from offsetting costs and reimbursements that were not billed to its fulfillment partners. Therefore Q3 2008's reported net loss of $1.589 million may have been lower than previously reported. If Overstock.com's Q3 2008 net loss was just $100,000 lower, its claimed improvement in reducing losses in the following year would have disappeared.

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 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.

Other information:

List of all blog posts (in date order)

Media commentary and mentions (in date order)

Overstock.com (NASDAQ: OSTK) Q3 2009 Earnings Call Questions for Patrick Byrne

2009-11-03T13:19:00.002-05:00

To Patrick Byrne:

You have denied me personal access to the conference call and have provided arbitrary and unreasonable conditions not imposed on other participants in the call. In any case, I will be seeking access to the call to ask possible follow up questions.

You are perfectly aware that some of my questions involve complicated accounting issues and cannot reasonably be kept to 25 words or less.

Enclosed are my four questions. I request that you read each of them out loud into the record, in full, and provide detailed answers to each question.

Please answer "yes" or "no" to questions one, two, and three before responding to the issues:

1. Did Overstock.com's EBITDA calculations reported from Q2 2007 to Q2 2008 violate SEC Regulation G?

2. Did any Overstock.com financial report issued from inception initially comply with GAAP and SEC disclosure rules?

3. Did Overstock.com violate GAAP in accounting for underbilled offsetting costs and reimbursements from fulfillment partners and create a cookie jar reserve for the purpose of manipulating future earnings?

You have previously claimed that Deep Capture is unrelated to Overstock.com.

4. Why did you respond to my request to participate in the Q3 2009 earnings call by posting my private email and your response on Deep Capture?

Regards,

Sam E. Antar

Disclosure:

Other information:

List of all blog posts (in date order)

Media commentary and mentions (in date order)

Patrick Byrne To Tough It Out With SEC Over GAAP Violations

2009-10-26T22:49:00.025-04:00

Apparently, Overstock.com (NASDAQ: OSTK) is going to stubbornly tough it out and force the Securities and Exchange Commission to take enforcement action to make its financial reports comply with Generally Accepted Accounting Principles (GAAP). The SEC re-opened its investigation of Overstock.com in response to a series of investigative reports by this blog documenting continuing GAAP violations by the company and other false and misleading representations to investors by its management team, led by CEO Patrick M. Byrne.

Flawed financial reports incorporated in new registration statement

Earlier today, Overstock.com filed a registration statement in connection with its 2005 Equity Incentive Plan. CEO Patrick M. Byrne, CFO Steven J. Chesnut, audit committee members Allison H. Abraham, Clay Corbus, and Joseph J. Tabacco Jr. all signed off on Overstock.com's SEC filing. In addition, PricewaterhouseCoopers (PWC), Overstock.com's former auditors, consented to the company using flawed financial reports in its SEC filing. See below:

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in this Registration Statement on Form S-8 of our report dated February 23, 2009 relating to the financial statements, financial statement schedule and the effectiveness of internal control over financial reporting, which appears in Overstock.com, Inc.’s Annual Report on Form 10-K/A for the year ended December 31, 2008.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

Salt Lake City, UT

October 26, 2009

As I will detail below, Overstock.com's 2008 Annual Report on Form 10K/A contained material accounting errors and GAAP violations that were overlooked by PWC during the course of its audit. Therefore, internal controls of financial reporting was ineffective. Worst yet, PWC has given similar consents to Overstock.com in the past, only to have such financial reports later restated due to GAAP violations.

Summary of latest GAAP violations exposed in this blog

In October 2008, Overstock.com disclosed new customer credit and refund accounting errors and restated all financial reports from Q1 2003 to Q2 2008 to reflect an additional $8.2 million of claimed accumulated losses in prior reporting periods. It was the second time in two years that Overstock.com restated its financial reports due a violation of GAAP. PWC had erroneously given clean audit opinions on the company's financial reports before each restatement correcting GAAP violations for such reports.

Those customer refund and credit errors also caused Overstock.com to underbill earned income due from its fulfillment partners for offsetting costs and reimbursements. Overstock.com restated its prior financial reports to correct its customer refund and credit errors. However, the company failed to make offsetting corrections and properly accrue underbilled income earned from its fulfillment partners in those same affected prior reporting periods, as required by GAAP.

Instead, Overstock.com improperly recognized income from its underbilled fulfillment partners using a non-GAAP cash basis as amounts were collected future accounting periods: Q4 2008 $1.8 million, Q1 2009 estimated at $1.4 million, and Q2 2009 $87k. For additional details see SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8, 22, and 23.

In effect, Overstock.com improperly created a "cookie jar reserve" to inflate earnings in future reporting periods. For example, the company should have reported a Q4 2008 loss, but instead reported a profit for that quarter by violating GAAP. That improperly reported net profit enabled Overstock.com to report its first quarterly profit after a string of 15 consecutive quarterly losses and beat mean analysts’ consensus expectations for earnings per share (See: SEC Staff Accounting Bulletin No. 99 about Materiality).

Overstock.com's phony "gain contingency" excuse

After my early blog posts (here and here) detailing Overstock.com's above GAAP violation, the company later claimed that when it initially discovered the accounting error, it immediately determined that a “gain contingency” existed on underbilled amounts due from fulfillment partners because "recovery of such amounts was not assured." See below:

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. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the partner and the partner had the wherewithal to pay).

Note: Bold print and italics added by me.

However, in my report to the SEC, I showed that no gain contingency existed because:

(1) The company already earned amounts due from underbilling its fulfillment partners in prior reporting periods,

(2) Its fulfillment partners were already contractually liable to pay all underbilled amounts from prior reporting periods, and

(3) The collection of large sums of such underbilled amounts due from its fulfillment partners was reasonably assured.

Both Overstock.com and PWC had to know that the collection of significant amounts due from underbilling of its fulfillment partners was assured, contrary to its disclosure that "the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency."

Overstock.com floats the cash that it receives from customers and is later required to pay fulfillment partners in up to 30 days. The company has the right to offset various errors against future remittances to its fulfillment partners. The company can withhold a larger portion of the monthly remittances from such fulfillment partners (up to a few months, if necessary) to recover underbilling errors.

Overstock.com did not have to reach an agreement with its fulfillment partners on underbilled amounts as it claimed, since its supplier agreement already allowed for such offsets (Source: Overstock.com correspondence to SEC Division of Corporation Finance). In addition, the greatest amount of the underbillings would certainly be attributable to its higher volume fulfillment partners who sold the most merchandise and are likely to be long time and current company suppliers.

Therefore, Overstock.com's ability to recoup a substantial share of previous underbillings to fulfillment partners could have been reasonably estimated, as required by Statement of Financial Accounting Principles No. 5. In many ways, Overstock.com's recovery of underbilled amounts due from its fulfillment partners was far more certain than recouping money in ordinary credit card disputes from its average customers.

In the eighteen months prior to disclosing its accounting error, the gross potential amount the company underbilled its fulfillment partners was about $4.7 million (See my calculations here). Over $3 million of such amounts due from underbilling its fulfillment partners was actually recovered within weeks and months after the company initially discovered the underbilling errors.

Overstock.com and PWC should have also considered subsequent corrected billings to and collections from fulfillment partners after the cutoff date of each financial report and before it filed its respective Q3 2008 10-Q and full year 2008 10-K reports with the SEC.

In other words, if new information, known as "subsequent events" is received after the cut-off date of a financial report but before the filing of such report which affects either assets or income in that financial report, a company must adjust its financial report to reflect that new information. (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk").

Therefore, no gain contingency existed since underbilled amounts due from fulfillment partners was already earned, the fulfillment partners were already contractually required to pay such underbilled amounts, and a substantial amount due to the company from underbilling fulfillment partners was reasonably assured, contrary to company disclosures.

In any case, Securities and Exchange Commission’s interpretation of accounting rules is that “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error.” (Source: Cease and Desist order issued “In the matter of Carl M. Apel”). Overstock.com cannot defer income from underbilling its fulfillment partners to future accounting periods.

New Evidence of a botched audit by PWC and Overstock.com's failure to take into account subsequent events

In its Q3 2008 10-Q report, fiscal year 2008 10-K/A report, and Q1 2009 10-Q report, Overstock.com made no subsequent events disclosure. However, in Q2 2009 10-Q report, the company finally made such a disclosure (Footnote 15, page 22):

Management evaluated activity of Overstock.com through July 31, 2009 (the issue date of the Unaudited Consolidated Financial Statements) and concluded that no subsequent events have occurred that would require recognition in the Unaudited Consolidated Financial Statements or disclosure in the Notes to the Unaudited Consolidated Financial Statements.

Note: Bold print and italics added by me.

Why was the subsequent events disclosure omitted from prior financial reports? As I detailed above, Overstock.com failed to consider subsequent corrected billings to and collections from its fulfillment partners. Overstock.com's 2008 10-K/A financial report was audited by PricewaterhouseCoopers and the 2009 10-K financial report will be audited by Grant Thornton.

Note: A reader has alerted me that Overstock.com’s subsequent events disclosure in Q2 2009 is new required disclosure under SFAS 165. In any case, Overstock.com was required to take into account those subsequent events (corrected billings to and collections from its fulfillment partners) and the company was required to make subsequent events adjustments and disclosures under existing accounting guidance and SEC rules at the time financial reports were issued for Q3 2008, Q4 2008, and Q1 2009. In addition, as I detailed above, no gain contingency existed for underbilled amounts due from fulfillment partners as claimed by the company. Therefore, PWC still botched the 2008 audit.

Grant Thornton

Grant Thornton, will face a dilemma. Overstock.com’s GAAP violations in 2008 caused material errors in 2009 financial reports that Grant Thornton must audit. Will Grant Thornton will go out on a limb and risk issuing a clean audit opinion without Overstock.com restating financial reports to correct its GAAP violations?

Written by:

Sam E. Antar

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Media commentary and mentions (in date order)