Conservatism is no excuse for false financial statements, Overstock.com

I’ve written extensively in the past about the train wreck that is Overstock.com (NASDAQ:OSTK) and its nutty CEO, Patrick Byrne.  Just when I think there couldn’t possibly be more to write about the horrible company and Byrne’s crazy antics, I’m proven wrong.

For those that have been following Overstock.com for the past few years, it came as a great surprise that the Securities and Exchange Commission decided to investigate the company and its financial reporting. It came as a surprise because for three years, Sam Antar (former CFO of Crazy Eddie and convicted felon) has been exposing their financial reporting misdeeds on his blog. Yet the SEC didn’t seem willing to take any action.

The last time Patrick Byrne and Overstock.com received an SEC subpoena, Byrne says he celebrated.  That investigation was dropped in June of 2008. But the investigation into financial reporting irregularities has been re-opened. This time, there doesn’t appear to be any celebrating.

Of course, Byrne lauded the SEC’s previous inaction as an essential vindication of his company’s numbers. Surely the SEC would do something if there were improprieties?

Not necessarily. In Byrne’s world of make-believe, the absence of an investigation or action means he’s squeaky clean. In the real world, it simply means there’s no investigation or action. I mean…. I could murder a person, the police might not be able to charge me with a crime, but that doesn’t undo the murder. We all recognize that there are many reasons why law enforcement may be unable or unwilling to bring a case against someone.

But the SEC finally decided to do something about Overstock.com. It’s about time!

If you care to read all the gory details of Overstock.com’s financial misdeeds, you can read Sam Antar’s detailed article about it. In a nutshell, there are numerous instances of Overstock.com manipulating the company’s financial statements to create phony profits and meet analyst expectations. Most recently, the company has taken to creating “cookie jar reserves” to manipulate the financial statements.

To those not versed in accounting speak, “cookie jar reserves” are essentially reserves that are set up in the accounting records, which management can dip into, depending on how they need their financial statements to look at the end of the period.

The reserve creates an expense on the books when it is set up. Sounds bad, right? Who would purposely create an expense that is either unnecessary or too large? Plenty of companies would, especially if the companies are already in an accounting period that is in the red. If you’ve already got a losing quarter or year on your hands, who cares if you make that loss a little bigger by adding a phony reserve?

What’s the purpose, you ask? In later accounting periods, management can go to that reserve to make their books look better. Simply put, management can dip into that reserve when necessary, and the result of undoing part of the reserve is to record income (the opposite of the expense that was booked when the reserve was originally created).

That doesn’t sound okay, does it? Of course it doesn’t. It’s not okay to set up reserves so that you can play around with them to manipulate the financial statements. Reserves have a particular purpose in the accounting world, and it’s not to treat them as a cookie jar.

Yet that’s exactly what Overstock.com has been doing. I detail how they’ve been doing that in this post. And here is Sam Antar’s detailed explanation of this cookie jar accounting done by Overstock.com.

Every time we turn around, Overstock has found a prior period accounting error, and depending on how management decides they want the financial statements to look, they make up an accounting treatment for the error. To hell with the accounting rules. Overstock will decide what the rules are and therefore how they will report their repeatedly screwed up numbers.

How screwed up are the books at Overstock? As I reported previously:

For about the trillionth time, Overstock.com has found an accounting error that affects the prior period financials. Going back just to 2003…. you see that every single quarter has had accounting errors which mean the financial statements are not correct.  The obvious conclusion a reader should draw is that management at Overstock.com cannot keep an accurate set of books, and anyone who looks at their financial statements and makes any decisions based on those is an idiot.

Sam Antar says it goes back even further:

Since CEO Patrick Byrne took control of Overstock.com in 1999, every single financial report issued by the company has at least initially violated GAAP and other SEC disclosure rules. (A summary is detailed in my blog post here).

What is Patrick Byrne’s response to the allegations (and solid proof, if I might say so myself) that the company is consistently violating Generally Accepted Accounting Principles when it issues, re-issues, and re-re-issues financial statements?

He’s simply a victim, as stated in this “news” story about the SEC subpoena:

“Any time a company has two restatements in three years, it draws more scrutiny. That looks strange,” he said, before quickly adding, “I think this last year has shown that the SEC is under the thumb of Wall Street. There are powerful players … who can get an investigation started.”

And the fact that Gary Weiss and Sam Antar have repeatedly pointed out Overstock’s financial misdeeds? They’re villains:

Byrne, known for his role in convincing regulators to tighten the screws on a controversial market strategy known as “naked short selling,” said Antar’s characterization and Weiss’ assertion that bloggers rekindled the investigation are wrong.

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

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

Byrne’s usual tactics of deflecting and making bigoted characterizations of his critics are not unexpected. He’s trying to tell us “move along, nothing to see here”…. All the while acknowledging that the company’s financial reporting has been in chaos since the start.

Byrne would have us all believe that the accounting rules are flexible and he’s a boy scout who’s just trying to follow the rules:

Our accounting department is a bunch of square Utah Eagle Scouts,” Byrne said. “Their instructions were to keep the books conservatively. In 2006, our auditors said we were being too conservative.

But the fact is that Overstock.com can’t produce an accurate financial statement to save their lives. And conservatism is no excuse for filing false financial statements.

The truth is that most recently, Overstock.com made up a “gain contingency” so that they could report the numbers when and how they preferred (i.e. the most advantageous to the company).  The way that Overstock reported their errors had the effect of distorting quarterly results. The cumulative effect of these errors isn’t the only consideration. What would happen if the transactions in question were reported in the proper quarters? The whole picture of the financials over the quarters changes.

And that’s why Overstock isn’t just permitted to make up new accounting rules that allow them to report numbers whenever they please. And citing an accounting principle of “conservatism” (which is usually a good thing, in the eyes of auditors) doesn’t get them off the hook either.

Oh, why bother with those pesky financial reporting regulations anyway. I mean, there certainly are more important issues to worry about, aren’t there? Like maybe a company issuing more shares of stock than it had registered with the SEC ???

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