Overstock.com Litigation Update 2010

Overstock.com’s litigation portfolio has changed significantly in the past few months, with the $5 million settlement of the Rocker litigation and the expanded scope of the pending SEC investigation of Overstock.com. In addition, it appears that the Great Naked Short Selling Conspiracy lawsuit against the major prime brokers is petering out, and will soon settle for nuisance value or be discontinued by Overstock.com.

The Rocker case $5 million settlement was proclaimed a victory by Overstock.com for itself, its shareholders, and the investing public. After expenses, there isn’t much left for the shareholders. Thus ended a “crusade” that was supposed to be worth a fortune to Overstock.com.

Unfortunately for Overstock.com, that didn’t end the matter. Overstock.com internal emails by ex-CFO David Chidester , produced in discovery in the Rocker case, were obtained and utilized in an article by Roddy Boyd to contradict Overstock.com’s contemporaneous SEC filings that it had adequate internal controls. Chidester resigned effective immediately. Overstock.com CEO Patrick Byrne wrote a blog saying Boyd had “…less dignity than a wino giving $2 hand-jobs at the bus station” and subsequently said there were a number of financial journalists whom he’d like to “kick in the throat.” Byrne has since been unavailable for comment. Overstock.com has filed a motion that the disclosed documents were under a protective order, but that horse already left the barn.

Worse yet, the SEC has subpoenaed the Rocker litigants for the documents produced in discovery in Overstock.com’s lawsuit against Rocker et al. No confidentiality order in the prior civil case can immunize these documents from production to the SEC; by definition they were produced in discovery to the adverse party and so are not privileged. This expanded SEC inquiry coincided with Overstock.com’s firing of Grant Thornton in an acrimonious dispute, the engagement of KPMG, and the third restatement in three years as Overstock.com was forced to restate 2008-2009.
The expanded SEC inquiry is highly likely to bear fruit since the very first leaked documents immediately led to the ex-CFO resigning and Overstock.com filing that its prior financials cannot be relied upon. The SEC is highly likely to bring an enforcement proceeding against Overstock.com and certain officers regarding false financial statements and false Sarbanes-Oxley certifications.

The Great Naked Short Selling Case appears to be petering out, despite Overstock.com’s pledge to pursue the case to trial solely represented by Stein & Lubin now that John O’Quinn has passed and Wes Christian is no longer involved. The cost to actually conduct e-discovery of epic proportions to prosecute the case is in excess of $25 million in 2010-2012, and the court Docket reflects a decided slowdown in Overstock.com’s “vigorous” prosecution of the action. The most likely scenario is a settlement in the range of below-Rocker to about $5 million, with the defendants simply being pragmatic, or an actual discontinuance by Overstock.com. Overstock.com is now in defensive mode and cannot fund or waste management resources on another “crusade.”

Overstock.com has filed a Form 8-K stating that it expects to be profitable for 2009 after restating to correct “errors.” NASDAQ listing requirements and SEC reporting rules mandate audited financials within required time periods. There is a high probability that KPMG, which was engaged December 23, 2009, will conduct additional procedures in light of the recent withdrawal of the prior financials, the expose of internal emails contradicting the SEC filings, the immediate departure of the ex-CFO who was the author of the emails contradicting the SEC filings, and the SEC expanded inquiry subpoena for the balance of the documents. In my opinion, KPMG will resign the engagement if there is reason to doubt management integrity, and will not be rushed into issuing an audit opinion by NASDAQ-listing deadlines needed to avoid Overstock.com becoming a Pink Sheet or Bulletin Board stock.

If the internal emails by the ex-CFO are, as I expect, only the tip of the iceberg, then KPMG’s additional procedures, with the SEC inquiry pending, will ascertain if these internal control and reporting issues are only “errors” or whether the conduct rose to the level of “irregularities.” In the latter case, Overstock.com may end 2010 with no significant recovery in its crusade against naked short-selling “Sith Lords” and their minions of imagined miscreants, exposure of years of internal controls and reporting issues, and a wary or already-departed KPMG.

Don’t hold your breath waiting for Overstock.com to report restated financials audited by KPMG.

Disclosure: I have represented Sam E. Antar, who exposed Overstock.com’s accounting shenanigans despite vicious and unlawful Issuer Retaliation against him and other critics of Overstock.com, including me. I believe that the above analysis is correct but I do have an axe to grind here.