Case 2.11

Overstock.com, Inc.309Patrick Byrne, a bon vivant and protg of Warren Buffet, founded Overstock in 1999. A decade later, a questionable gain contingency recorded by Overstock sparked a dis-pute between Byrne and his companys audit firm. That dispute spawned a series of public and contentious exchanges between the two parties.

"In March 2000, the Securities and Exchange Commission (SEC) began requiring pub-lic companies to have their quarterly financial statements reviewed by their inde-pendent auditors. The broad purpose of this new requirement was to improve the quality and credibility of quarterly financial reporting. A more specific goal was to reduce the frequency of accounting restatements by SEC registrants. In addition, the SEC hoped the new rule would serve to counteract the increasing pressure being imposed on public companies to manage their interim financial results.1On November 16, 2009, Overstock.com shocked its stockholders, regulatory author-ities, and Wall Street by filing a unreviewed Form 10-Q with the SEC. In a press release issued that same day, Patrick Byrne, Overstocks mercurial chief executive officer (CEO), reported that the decision to file the unreviewed 10-Q had been neces-sary because of an unresolved dispute with Grant Thornton LLP, the companys audit firm. That dispute centered on the proper accounting treatment to apply to an unusual transaction involving one of Overstocks business partners. Byrne also revealed that the company had dismissed Grant Thornton as a result of that disputelater that day, Overstock filed a Form 8-K with the SEC reporting the audit firms dismissal.Overstocks surprising decision to file an unreviewed 10-Q with the SEC caused the investment community to wonder what would happen next. How would the SEC react to Overstocks decision to seemingly thumb its nose at the federal securities laws? Would the NASDAQ stock exchange suspend the trading of Overstocks com-mon stock? When or would Overstock be successful in retaining another accounting firm to serve as its independent auditor?Buffett, Byrne & The BubbleBefore entering the business world, Patrick Byrne, the son of a wealthy associate of Warren Buffett, lived the life of a bon vivant and Renaissance man. After spending time as a student in China, Byrne earned an undergraduate degree from Dartmouth, a Masters degree from Cambridge, and a doctorate in philosophy from Stanford. In addition to accumulating an impressive educational portfolio, Bryne traveled the world, earned a black belt in martial arts, made a brief foray into professional box-ing, and served as a university instructor.Warren Buffet launched Patrick Byrnes career in the field of corporate management in 1998 when he asked him to serve as the interim CEO of a financially troubled subsidiary of Berkshire Hathaway, Buffetts flagship company. Eighteen months later, Byrne struck out on his own when he acquired a controlling interest in a small online company based in Salt Lake City that marketed excess and closeout merchandise over the Internet. Byrne was convinced that with the proper business plan, capitalization, and management team in place, the companys core concept could be wildly profitable. Over the following few months, Byrne appointed himself CEO, invested several million dollars to expand the companys operations, and renamed it Overstock.com."

"In 2000 and 2001, the spectacular bursting of the dot.com bubble decimated hundreds of New Age Internet-based companies that had sprung up like wild mush-rooms over the prior decade. The resulting carnage caused the NASDAQ Composite Index that is laced with e-commerce companies to decline by approximately 80 per-cent in less than three years. While most online companies were either being forced to shut down or signifi-cantly curtail their operations, Patrick Byrne recognized that the dot.com debacle created an opportunity for his company. Overstock began liquidating the unsold merchandise of failing online businesses at fire-sale prices. In 2002, the companys growing revenues and apparently strong business model caused Business Week to name Byrne one of the 25 most influential corporate executives in the rapidly evolv-ing e-commerce sector of the national economy. That same year, Patrick Byrne took Overstock public, the first online retailer to do so in almost two years. The company raised $40 million with its initial public offering (IPO) and listed its common stock on the NASDAQ stock exchange. Gradually, two distinct lines of business emerged within Overstocks exclusively online operations. Overstocks Direct line of business sold merchandise that it had acquired from other sources to individuals and companies. In Overstocks much larger Partner line of business, the company served as an intermediary or sales agent for more than 3,000 business partners.2Overstock earned a commission on the merchandise sales that it arranged or facilitated for those partners. For account-ing and financial reporting purposes, Overstock recorded most sales of partners merchandise as gross revenue and then subtracted the cash remittances made to those partners as cost of goods sold; the differences between those amounts repre-sented the commissions earned by Overstock on the sales transactions.overstocked on ProblemsBy 2009, Overstocks annual revenues were approaching $1 billion; one decade earlier, when Patrick Byrne acquired the company, it had annual revenues of a few hundred thousand dollars. Despite the companys impressive revenue growth, the company struggled to become profitable. When the controversy arose regarding Overstocks unreviewed 10-Q in November 2009, the company had yet to report a profit for a full fiscal year. Making matters worse, the companys stock had been pum-meled in the market over the previous several years, falling from a high of $76 per share in December 2004 to less than $15 per share by November 2009. Several factors, in addition to Overstocks recurring operating losses, caused investors to shy away from the companys common stock. Patrick Byrne, himself, attracted a storm of negative attention to the company by the relentless attacks that he unleashed on major Wall Street firms and regulatory authorities. Byrne claimed that several hedge funds and other large institutional investors were driving down the price of Overstocks common stock and attempting to destroy the company. Those parties efforts allegedly involved naked short selling of Overstocks com-mon stock, a tactic that in most circumstances is illegal.3Byrne insisted that regulatory authorities responsible for policing the nations stock markets, including the SEC, were involved in the conspiracy to destroy Overstock" "and other companies targeted by the alleged cartel of naked short sellers. According to Byrne, those regulatory authorities refused to prosecute or otherwise rein in the naked short sellers. Byrnes fierce and highly public crusade caused Overstock to take the unprecedented step of listing its CEO as a risk factor faced by the companypublic companies are required to identify in their periodic SEC filings the major risk factors that could undermine them. Overstock reported in multiple SEC registration statements that controversial public statements made by Byrne, particularly those directed at the SEC, might focus unwarranted regulatory attention on the company. Even more disconcerting to potential investors than Byrnes bombastic persona were the companys recurring accounting problems. During its first several years as a public company, Overstock restated prior financial statements multiple times. Audit Integrity, a forensic consulting firm, reports accounting and governance risk (AGR) measures for public companies that are intended to be predictive of financial statement fraud. Overstocks repeated restatements caused Audit Integrity to assign Overstock a aggressive AGR rating.4The November 2009 disclosure of Overstocks dispute with Grant Thornton raised the possibility that the company might be forced to restate its prior financial statements once more. Overstock was also criticized for using pro forma accounting measuresearnings before interest, taxes, depreciation, and amortization (EBITDA) in particularto draw investors attention away from, and downplay the significance of, its recurring operating losses. Sam E. Antar, a self-appointed crusader against financial reporting fraud and the author of a blog entitled White Collar Fraud, charged that Overstock improperly and opportunistically computed the EBITDA amounts that it reported to investors.5 cookie Jar Accounting The dispute that culminated in Overstocks audit committee firing Grant Thornton was triggered by an error made by the companys accounting staff in 2008company officials readily admitted that the error resulted from a deficiency in Overstocks internal controls. The accounting error caused Overstock to remit a $785,000 overpayment to one of its business partners, which overstated Overstocks cost of goods sold for 2008 by the same amount. Because of uncertainty regarding whether the $785,000 would be recovered, Overstocks accounting staff character-ized the over-payment as a gain contingency and chose not to record a correct-ing entry for it.6Overstock recovered the overpayment from its business partner during the first quarter of 2009. The companys accountants recorded the offsetting credit for the $785,000 cash receipt as a reduction in costs of goods sold for that period. To assess the impact of the $785,000 amount on Overstocks 2008 and first-quarter 2009 financial statements, refer to Exhibit 1, which presents selected financial data initially reported by Overstock in its 2008 Form 10-K and its 10-Q for the first quarter of 2009."

addresses the following

1. Incorporate common themes from the cases related to the weeks topic, including some background on each case.
2. Identify lessons learned from the cases collectively.
3. Offer recommendations to prevent future occurrences.