As people consider the role of the financial media in the economic collapse of the past several years, a common refrain is that the media fell down on the job. The point has its merits: While there was some intrepid work done on individual mortgage lenders, for the most part neither the financial trees nor the economic woods were particularly well-illuminated. The Columbia Journalism Review has assembled a thorough, and gimlet-eyed, analysis of the media’s failures.
Too often, though, critics underestimate the difficulty and the cost of doing aggressive business journalism that companies don’t like. There is an ugly truth to doing investigative reporting on a company’s financial state of affairs: It is far from a precise science. A curious business reporter can frame the gap between a company’s otherwise decent profits and weak cash-flow generation but can’t responsibly go much further than laying out some accounting considerations. The vastly more worrisome issues that a company chooses not to disclose can be kept safely from the public’s view for decades.
Then there is the push-back. Corporations have everything to lose from bad press: credit-rating downgrades, regulatory investigations, lost business, and, above all, a possibility of stock-price declines. So as often as not, they fight a tooth-and-nail battle with investigative reporters and editors to tone down, delay, or even kill looming bad press. Outside public relations and law firms can turn an extraordinary amount of heat on increasingly over-matched editors and lawyers on the reporter’s side of the fence.
The most extreme form of this behavior comes from Overstock.com, a Salt Lake City-based Internet retailer that is in the news almost as frequently for the outrageous pronouncements of Patrick Byrne, its founder and chief executive, as it is for selling retailers' surplus inventories. Byrne is best-known for his quest to eradicate naked short-selling, a violation in which a trader fails to borrow stock adequately prior to selling it short. He believes that a far-reaching conspiracy of reporters, hedge-fund managers, and regulators are in league to abet naked shorting. He calls this “The Miscreants Ball” and says that the whole process is controlled by a legendary 1980s vintage criminal mastermind whom he terms “The Sith Lord.”
I am, in fact, one of the business reporters Byrne has castigated most frequently. While he and his colleagues at his DeepCapture.com site have spewed venom at many business reporters, I am one of only two reporters—the other is my former Fortune magazine colleague Bethany McLean—apparently evil enough in his eyes to warrant a reference to oral sex and ejaculation in his assessment of our ethics and reporting skills.
Before examining just how abusive Byrne can be to the press, some back story is warranted.
Between 2003 and 2005, Overstock’s mercurial revenue growth and stock price appreciation—it went from about $11.50 to about $47 (and hit a high of $71) between mid-August 2003 and mid-August 2005—had become a matter of some debate. Gradient Analytics, an independent research firm specializing in the deep analysis of company accounting, began to sharply question Overstock’s business model in the summer of 2003. In October 2004, it released a report detailing what it termed Overstock’s “Fatal Flaw,” arguing that the company was doomed to an endless cycle of quarterly losses because of poor customer loyalty and decreasing returns on its growing marketing outlays.
In February 2004, noted short-selling hedge fund Rocker Partners began to short Overstock’s shares with the view that Byrne’s business model was flawed, that the company had flubbed a number of corporate initiatives, and that Byrne had never delivered on his promises to turn profits. In August 2005, Overstock responded by suing Gradient and Rocker in California Superior Court, alleging that Rocker controlled both the timing and content of Gradient reports. After a bitter and contentious 4.5 years, Rocker—which changed its name to Copper River in 2006 and shut down in 2008—reached a settlement with Overstock last month. To save litigation costs from the trial and the near-certain appeals, according to a press release issued by Copper River General Partner Marc Cohodes, the fund paid Overstock $5 million.
Getting a settlement inked appears to have been the shrewdest move Overstock’s Byrne has ever made, because the details that would have been made public would vindicate much of the press criticism of Overstock over the last several years. The Big Money has obtained documents showing that in the months after Overstock filed its lawsuit, a series of mishaps surrounding its bungled inventory-management software upgrade pushed it into some dire financial straits. The crux of the problem—which had been building for several months while Byrne railed against short-sellers and sundry business reporters—was that since Overstock’s software system couldn’t track its inventory well, its accounting staff had trouble deciphering how much it owed and whom it had to pay.
Accounting woes were just the start of Overstock’s problems. This series of cascading snafus led banks and other lending sources to cut back their exposure to Overstock. Wary that extended payment cycles were harbingers of a cash crunch, lenders—especially market-leading retail lender CIT—began backing away in the fall of 2005. “Unfortunately what we feared has begun. Some factors and banks have stopped insuring our payables,” former Chief Financial Officer David Chidester wrote in an e-mail sent on Nov. 14, 2005—to then-General Counsel (and current president) Jonathan Johnson, then-President Jason Lindsey, and CEO Patrick Byrne—underscoring the trouble Overstock was in.
Nearly two months earlier, on Sept. 22, 2005, another e-mail shows a furious Patrick Byrne recounting a brutal meeting. “I just sat with CIT. They confirmed that at one time we were reasonably good (not great), and have turned to shit in the last six months.”
In fact, as early as Aug. 17, an e-mail notified Chidester that CIT had canceled a $3 million line of credit.
Another series of e-mails originating from CFO Chidester to Patrick Byrne on Sept. 22 confessed that “We are in a bit of a temporary cash squeeze” as a result of Overstock’s decision to invest $50 million in a basket of foreign bonds indexed against Asian currencies held at Lehman Bros. Also not helping cash-flow matters, per the e-mail, was Overstock’s having to pledge $25 million to cover a $20 million line of credit at Wells Fargo. Chidester told Byrne that he was working on an agreement to borrow up to $25 million against the $50 million bond position.
Not quite Warren Buffett.
As late as Feb. 28, 2006, the company’s director of jewelry, Joanne Dalebout, e-mailed the company’s senior leadership telling them, “All [vendors] are saying that with Overstock in the papers a lot and the lawsuit they don’t think we will be in business and that we are too much of a risk? Also having problems with CIT not approving small orders.”
(A CIT spokesman declined comment, as did one of the CIT executives assigned to the Overstock account. Byrne’s complete, insult-laden response can be found here; effectively, he does not consider the problems his company had with CIT to have been material enough to disclose to regulators.)
In 2005, Overstock lost just under $25 million; in 2006, it lost more than $101 million. The company survived in large part because of some radical surgery: It shifted business models almost entirely to a fulfillment-partner model (allowing other retailers to move excess inventory on its site rather than buying inventory and marking it up); it cut costs; and it got another enemy of short-selling, Fairfax Financial Holdings, to buy its stock on two occasions at increasingly large discounts to its rapidly dropping market price.
And so the Overstock critics were more right about the company’s troubles than even they knew. The decline in the stock price from mid-August 2005’s $46.87 to $16.27 in mid-August 2006 was wholly attributable to business weaknesses that no reporter, analyst, or short-seller could possibly have detected.
Another instance of Overstock critics having the correct instincts, but getting some of the details wrong, is in the confusion surrounding the announcement of Overstock’s design-your-own-jewelry initiative in 2006. Pitched as a value-conscious alternative to online jewelry leader Blue Nile, and offering better quality than Wal-Mart—“For what you would spend elsewhere, you can get her a lot more diamond here,” went the slogan—Overstock dove into the bitterly competitive online jewelry market in January 2005.
What caught the attention of critics was its announcement in the first quarter 10-Q filing in May of 2005 that it had set up a “variable interest entity” to engage in these transactions. The entity had agreed to lend Overstock up to $10 million—$8.4 million of which had been extended in November 2004—for which it received a below-market interest rate of 3.75 percent and a 50 percent claim to all profits. Overstock also had an option to buy the 50 percent it did not own.
Jeff Matthews, a hedge-fund manager, author, and blogger who had long been critical of Overstock and Byrne, immediately seized on the unusual structure of the transaction. He wondered why Byrne, who had discussed the great opportunities they were seeing (and participating in) within the diamond market that January, had not disclosed something as material as the joint venture.
Gradient, in a research note on May 16, 2005, offered a more detailed criticism. The report raised several questions about the deal, including whether the deal was structured as a variable interest entity to “report the top line benefits of the jewelry business without reporting 100% of the unit’s losses.” For a company whose losses, even before the debacle of the software upgrade, were mounting, this was—to Gradient at least—a plausible scenario.
But the truth is much simpler: The deal seems to have been a tax dodge. The joint venture, struck with Moshe Krasnanski and his brother-in-law Mayer Gniwisch—a pair of veteran diamond merchants whom Byrne referred to as “Our Lubbavitcher friends”—had nothing to do with efforts to minimize accounting losses. In an e-mail to the board of directors, Byrne dubbed the process of recruiting the pair, who had set up the profitable online diamond-seller Ice.com, “Operation Heist and Freeze.” According to a memo, Overstock general counsel Jonathan Johnson prepared for the board of directors on July 13, 2005, the company’s VIE was designed to avoid a “nexus in the State of New York for sales tax purposes,” which means that the company would not have to collect, and pay out, sales taxes in the state. The diamond sales effort never really went anywhere for Overstock, and it was closed out during the holidays of 2006 with about $567,000 in accumulated losses, according to an internal balance sheet for the joint venture.
And so again Overstock’s situation and motives were arguably worse than the reporters and critics could have known. Yet even for raising objections that approximated the company’s true health, Byrne has hurled torrents of repeated—and often bizarre—abuse at reporters and analysts, in a manner one would think does not suit a chief executive officer of a publicly traded company.
Byrne has run a rather remarkable project out of his Deepcapture.com Web site—the site is an effort he staked for north of $500,000 that aims to discredit mainstream financial media because of their “capture” by rich hedge-fund managers—that sought to gather the names of all the friends listed on the Facebook accounts of various reporters, bloggers, and hedge-fund managers who were perceived to be friendly to short-sellers. This really happened. Done using subterfuge and aliases, it sought to demonstrate, according to Judd Bagley, the former Overstock spokesman who put together the site, the symbiotic linking of short-sellers and the reporters who he claimed cover them. More practically, the list included minor children, teenagers, and hundreds of people who had nothing whatsoever to do with Overstock, reporting, or short-selling. The result was something akin to a public-relations disaster for Overstock.
Of course, sharp criticism of reporters’ methods and motives have become relatively common, but Byrne has taken it to a new plane. On his Deepcapture.com Web site, he described my breaking the story of the collapse of Rocker Partners—a particularly unflattering portrait of the fund’s devastatingly ill-considered swap with Lehman Bros. on several equity positions that blew up just as the brokerage collapsed—using the phrase “mop-and-sponge-bucket” after he titled the article “Roddy Boyd Sucks It Likes He’s Paying the Rent.”
The conspiracy expands every time a reporter focuses on the financial fundamentals of a struggling company: Christopher Byron, Herb “The Lapdog” Greenberg, Carol Remond, Jesse Eisinger, Gary Weiss, Cheryl Strauss Einhorn, Joe Nocera, and Floyd Norris, the reporters who have done the epic and heavy lifting in holding American businesses accountable for problematic practices in the past 20 years, are, in his mind’s eye, the enemy. Above all else though, Byrne’s attention has most often come back to Bethany McLean. Even after making his “bl** job” comment, he described her book The Smartest Guys in the Room as a “lotion job” about noted short-seller Jim Chanos.
For a man who claims to have learned investment management (and much else) at the feet of Warren Buffett, it’s a fair bet he never heard Buffett—who does, indeed, have a salty side—act like this. More directly, it’s hard to see how he helps Overstock or his sundry causes in this fashion. Regardless of whether shareholders agree with him or not, it is an inarguable fact that they have not benefited from his efforts.