Friday, August 10, 2012

Emails Describe Overstock.com Waging War -- On Behalf of its Enemies

Byrne's suit hasn't worked out too well.
In case anyone has missed it, here's a link to my article in the latest issue of Barron's, which explored the latest chapter in the ongoing saga of Overstock.com and its crusade against sanity.

Overstock has been hyperventilating for months about some emails that were inadvertently made public in its 2007 lawsuit against 11 prime brokers. Nine of the defendants were dismissed or settled, and the holdouts are Goldman Sachs and Merrill Lynch. The emails, disclosed in this court filing, received a flurry of publicity when they were first revealed, mainly a Rolling Stone blog, but since then haven't gotten much ink.

That's a shame, because there is a really amazing, ironic twist to this suit. It seems that Overstock is spending millions of dollars in legal fees to benefit its enemies--the short-sellers who rightly believe that this company is cooking its books, mismanaged, grossly unethical, and generally on its last legs.

Overstock claims in its suit that it was a victim of a conspiracy by the prime brokers to drive down its share price. Now, ask yourself: why would the prime brokers give a damn about Overstock's share price? They don't. And the emails don't say a word about Overstock or its nutcase CEO, Patrick Byrne.

But the prime brokers do have a motive to maximize their profits. The emails suggest that they may have done so by loading up on stocks for their stock-loan departments that were created via naked shorting, specifically by options market-makers who used a trading technique called a "reverse conversion." Then they charged their customers for borrowing the shares -- when they weren't borrowed.

As I point out in the article, short-sellers have been complaining for years about prime brokers cheating them by not borrowing stocks on their behalf. Hedgie Marc Cohodes, one of the short-sellers that Byrne targeted in a separate lawsuit, has contended that Goldman put him out of business and has intimated that it did so to cover up naked shorting.

I didn't have space in the piece to explore the depth of the short seller discontent, which included a class action lawsuit filed against the same prime brokers in December 2006, months before Overstock filed its suit.

Here's a copy of the short sellers' 2006 lawsuit. Note that the shorts' suit complains about pretty much the same conduct that appears to be discussed in the emails. Aside from alleged price fixing, Bloomberg reported at the time, "the plaintiffs also claimed that the firms don't require one another to deliver 'hard-to-borrow' securities, enabling them to charge borrowing fees for securities that never actually change hands." The suit was dismissed on a technicality a year later.

So, assuming there was chicanery here (which Goldman and Merrill both deny), the victims would be the short-sellers Byrne hates.

I guess that might explain why there was a spate of director resignations when Overstock's suit was filed back in 2007. I have to admit that I was slow to grasp the magnitude of this idiocy when the suit was first filed.
 
Adding irony upon that irony, Overstock will be on the hook for $2.4 million in court costs if its appeal of the suit, which was dismissed in January, is unsuccessful. Given the company's precarious financial situation, ongoing consumer fraud litigation by California district attorneys, and a libel suit against Byrne that is likely to go against him (both dealt with here), this suit is just another disaster for a company with no shortage thereof.

© 2012 Gary Weiss. All rights reserved.
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My latest book is AYN RAND NATION: The Hidden Struggle for America's Soul, published by St. Martin's Press. Click here to order the book from Amazon.com, and here to order it from Barnes & Noble. Follow me on Twitter @gary_weiss.

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