Overstock and Patrick Byrne Continue Naked Short Selling Jihad

Overstock and Patrick Byrne Continue Naked Short Selling Jihad

Thomas J. Catino November 8, 2005
Overstock.com (Nasdaq: OSTK) President, Dr. Patrick Byrne, has continued to up the ante in his vocal public battle against a coordinated campaign of short sellers who have allegedly targeted his company's shares. After appearing over the summer on a CNBC Street Signs segment with anchor Ron Insana, Byrne continued to emphasize that "what's at stake here is innovation and entrepreneurship in America." With strong words, Byrne said that his "company has been attacked and I'm not going to take this lying down."
Overstock.com, which launched its website in 1999 to sell products at wholesale prices, now has annual revenues of approximately $500 million. In the financial world, however, the company is not as well known for its business, but the controversy surrounding an alleged campaign to denigrate the company. Towards the end of the summer, Overstock.com filed suit against Rocker Partners and Gradient Analytics, alleging that the hedge fund and research company conspired to drive down the company's stock in a scheme known as naked short selling. Generally speaking, naked short selling is defined as selling a security short without borrowing the necessary securities to make a delivery, thus resulting in a failure to deliver the securities to the rightful owner. The main goal of naked shorting is to engage in harmfully affecting the stock price of a company in order to manipulate and create downward pressure on the security, affecting a company's ability to raise money on the open market, and ultimately profit from the downward movement in the company's shares.
In the civil complaint against Gradient Analytics, Inc., Rocker Partners LP., David Rocker, Marc Cohodes, and others, Overstock filed on the basis of unfair business practices. It was filed by John O'Quinn and his legal consortium, which has been instrumental in helping other naked short embattled companies in the past. The complaint alleges that Gradient Analytics, Inc., an influential company that sells reports and analyses on publicly traded companies to hedge funds, traditional mutual funds, and provides them to financial commentators such as MSNBC, is closely aligned with various stock hedge funds. The complaint goes on further by alleging that the Gradient and Rocker Partners LP, which is owned and controlled by David Rocker and Michael Cohodes, individually or through Rocker Offshore or Rocker Management, conspired to denigrate Overstock's business in order to reap personal profits for themselves.
While the financial press has been slow to document this, media coverage of this scandal gained momentum with another spirited Byrne conversation, this time on Fox News' Your World Today, with market veteran Neil Cavuto. During his appearance, Byrne claimed that there were "at least twelve Refco's buried in the system" that could result due to this ongoing problem of continuing fails to deliver, or naked short sales. According to the Financial Times, Refco (NYSE: RFXCQ) has over ten billion dollars worth of securities sold, that have not yet been purchased. It is rumored that these dollar amounts represent massive naked short sales, currently under review by major regulatory bodies.
When looking into the Securities and Exchange Commission legislation that should be able to enforce naked short sales, Regulation SHO, with its threshold security list, appears to be a miserable failure. This can be shown through Overstock's presence on the list for well over 100 straight days. In an exclusive interview that Ant & Sons conducted with the President of Overstock.com, Dr. Patrick Byrne, said that he agreed.
When discussing why the SEC had not initiated a buy-in or taken any enforcement action against those failures to deliver, he stated that the SEC is plagued by the fact that they are in an especially difficult situation because they are a "captured regulator." In other words, Byrne believes that "this is not a hard problem to solve," yet "it is just a hard problem to solve without a couple hundred guys on Wall Street getting their asses handed to them." While this may be considered blunt and extreme, it is Byrne's way of calling things as he sees them. However, intelligent investors could argue that Byrne's opinion on the lack of enforcement is quite accurate and is often seen as the unspoken truth on Wall Street. When asked about a potential solution to the problem, Byrne said in his plain spoken style that all that simply needed to be done was to "force settlements."
A while back, Ant & Sons spoke with Eagletech's CEO, Rodney Young, about his company's battle and ultimate downfall because of its inability to raise funds due to naked short selling. At the time, Young was labeled as being out of touch with reality because he claimed that there were potentially thousands of companies that have been "manipulated out of business" due to naked short selling. It now appears though that the problem is much more far reaching than previously thought, even though it has not gotten the appropriate attention in the financial press.
Although this may be the case, Byrne is quick to point out that an investor should first differentiate between the general problem of naked short selling, and his fight of battling against an orchestrated short selling campaign. Still, he admits that there are "hundreds, and historically, perhaps thousands" of cases where naked short selling has led to the downfall of many publicly traded corporations.
In response to this, naysayers tend to believe that Overstock's share price troubles are its own fault, due in part mostly to disappointing earnings results and its lack of a successful business model. Overstock has had many critics on Wall Street, including Jeff Matthews, an internet blogger and General Partner at Ram Partner Capital. He contends, like numerous other critics, that Overstock's allegations of a naked short selling conspiracy is only a cover up for the fact that Overstock's financial performance has not gotten better.
Byrne defended his company by speaking the truth, saying that "Q3 was rough" and it was "(his) bad." Last week, earnings came in below analyst expectations. Not shying away from the tough questions, Byrne said honestly that the company "bit off more technology projects than my colleagues could chew" and the "last bite, an ERP implementation, was one bite too many, and we choked on it."
He also acknowledged the intense criticism "for taking my eye off the ball to pursue a jihad" with his deluge of complaints and lawsuits against Rocker Partners and Gradient Analytics. Some financial journalists have targeted Byrne for going off into the deep end. In a past conference call, he stated that he started to realize that ".there was actually some more orchestration here being provided, by what I am calling here the Sith Lord, or mastermind" that was apart of a conspiracy to manipulate Overstock shares. Filing a lawsuit against Rocker Partners and Gradient is evidence that Byrne and company have confidence in their ability to expose the short selling "Sith Lord" and help to put to rest that these allegations are not just another stock market conspiracy.
For now, the bottom line is that Overstock will have to continue to rely on its own proactive approach and legal team to combat its naked short selling woes. Even with Chris Cox's public statement that the SEC is a "regime for law enforcement," there seems to be no follow through in action to his tough public words. The SEC has merely taken a back seat in all of this, failing to take any enforcement action when necessary, highlighting the continued ineffectiveness and regulatory failure of the SEC. However, with increasing evidence that naked short selling is not just a myth or fantasized market scandal, the pressure will only increase for regulatory bodies to do something meaningful about naked short selling.