The SEC & Me, Part Deux: Clusterfuck

Originally publish on 11/11/2019 by Patrick Byrne

On April 12, 2016 my relationship with the SEC began anew. I know the date because that day in Washington, DC I gave a speech at the Cato Institute, and the date appears on the title slide of my PowerPoint in the video. As I walked out of the Cato auditorium an exceedingly polite, sympathetic woman named Valerie Szczepanik approached me and handed me her card. It identified her as being with the SEC. She told me that she was in charge of a group at the SEC which was hoping to have an open dialogue with me about blockchain and its role in capital markets. She invited me to get in touch, visit her team at the SEC, and open up a solid, professional relationship where they would stay informed on and help guide us as we developed tZERO. She could not have been nicer or more genuine, and it remains a great regret of mine that after thanking her and walking away, I gave the information to someone then in a leadership position of tZERO, along with a lawyer for tZERO, and extracted a promise from they would follow up with her and build a relationship.

I did that because that talk was my last professional commitment: as I explained in another recent post, I had entered a window where there was roughly a 50% chance I would have organs being cut out of me by May or June. That morning I had announced another medical leave of absence, and I was walking away from everything that very day. If they were going to start cutting out more body parts in May or June, I did not want to be working in the office up until the last second, so I had decided to enjoy life a bit, and I took a medical leave to wait things out.

I say that it is a regret because, while the person and the outside lawyer promised me that they would do so, and while I subsequently asked numerous times whether things were going well with the SEC and was assured at least half a dozen times that they were, that the relationship was great, that they were being informed every step of the way, I was to learn two years later that they were flatly lying to me. In fact, my colleagues at tZERO and Jones Day had gone into porcupine mode, and were doing everything they could to stymie interaction with the SEC. That led us to blow what would have been a great opportunity to build a productive relationship with the SEC. I only learned the truth in 2018. Notwithstanding other sources of friction, when I had the opportunity to do so I apologized profusely on that score, and I meant it. I still shake my head at the idiocy of missing that opportunity. The SEC had asked for precisely the relationship of which I had dreamed. And Ms. Szczepanik has gone on to be named the so-called crypto-Czar within the SEC, the person overseeing everything blockchain within the SEC.

But I get ahead of myself.

By August, 2016 I was back at the helm of Overstock. We turned in another GAAP profitable our Retail business, making $32 million pre-tax (and over $50 million EBITDA), while our main competitor (Wayfair) lost ≈ $200 million. Yet we were faced with a dilemma: Wayfair, backed by Goldman and Bank of America, was a darling of Wall Street, and seemed to have access to the same pool of virtually unlimited cheap capital that our competitors have always tapped, but which has been denied to Overstock (for lots of reasons explored in the many essays, such as the willingness of some people with immensely deep pockets to pay interests rate averaging 90%, and as much as 350%, to maintain short positions that keep OSTK from budging, along with other reasons that were covered extensively in Part I of this story).

In early January 2017 I decided to try something that we had never done before: I decided to try a Wayfair strategy. We announced to Wall Street that we were going to accelerate but lose a lot of money. My hope was that we might start seeing the kinds of valuations that our competitors always had enjoyed, and might be able to resupply our coffers and switch to that more conventional Internet strategy for good.

The strategy failed. We succeeded accelerating, and our traffic got up to ≈20% growth, with revenue accelerating just behind it, but the market did not care. Again, trading in OSTK seems to follow rules unlike the entire rest of the market for eCommerce stocks (as was explored in Part I of this story). We had shown we could grow, we had shown we could make money, we had shown we could do it on a thimble of capital compared with everyone else, and the price of OSTK never responded.

In July of 2017 I wrote my Rabbi one of my long letters, and went out to see him for his advice. The basic dilemma I presented was this: we had shown we could make tens of millions of dollars, but for (then) 18 years we had faced a seemingly endless string of competitors who just burned through hundreds of millions of dollars, or even billions, which made it impossible to earn the hundred millions or more that I had expected we would be earning by that point.

When I arrived in Omaha I learned that, as is always the case, though he had studied my letter closely, Buffett still had me speak to it for 45 minutes (while in public Buffett is always talking, naturally enough, most people might be surprised to know that in private Buffett is a great listener, as great teachers are). I expanded on this point and that, I filled him in on this dynamic and that (Buffett’s understanding of the Internet and such matters as SEO is much more profound than people would guess). He asked me a few questions, primarily centered on this theme: what had we done differently that let us build something unique in our industry, a Retail website that made money, and do it on so little capital compared? I told him that it was a combination of two things: the business lessons he had taught me, plus a focus on agile technology development. We also explored the truth that had emerged by then, that brick-and-click is the winning model, due to its immense advantage over pure-brick or pure-click. This was and is especially true in the case of furniture, because of the impossibility of having reasonable real estate costs, high SKU-count, and local delivery, from a pure-brick-and-mortar retailer, or a pure online play. The advantages of doing furniture in a brick-and-click model exceeds perhaps any other brick-and-click model, and no one had done it yet (and to this day, they still have not).

There was a lot of exploration and amplification, a lot of talk about the previous two decades and all we had come through. He was complimentary, he noted that we were practically the only people in the industry who actually made money, he noted that we did it with a fraction of the capital everyone else used, but he concluded in his crackly Midwestern drawl, “You know Patrick, in boardrooms across America there are people who see two big steamrollers bearing down on them, Amazon and Wal-Mart. They have underinvested in their own websites, they are discovering it is turning out to be a lot harder to catch up than they expected… I really think you should solve someone else’s problem.” Meaning: Sell the Retail side of the business to a brick-and-mortar retailer who has underinvested in technology and who wants to leapfrog to a hybrid brick-and-click solution. Focus on blockchain.

I flew to New York and saw Ken Langone. He told me there was one banker he uses for anything to do with the Retail industry: Andrew Taussig, of Guggenheim. I contacted Andy, and by September we were putting the case together. He told me that the goal would be to get at least a couple players interested at the same time, and then force them to start bidding against each other for the firm. As I am sure all clients do, I asked him, “How long is this going to take?” He told me, “Patrick, selling a company is like baking a soufflé. It takes what it takes and there is no rushing it.”

That said, things heated up fairly quickly, and by January 2018 we were starting to move towards a fine ending to the story of Overstock Retail. Two gigantic retailers, both among the largest five brick-and-mortar chains in the USA, along with two fine medium-sized retailers, did significant due diligence. I heard backchannel (through Marc Cohodes, so I cannot vouch for the veracity) that the CEO of one of the firms was trying to find out if we would take $1 billion for the Retail business (our market cap then being $1.5 billion). It looked like the soufflé was going to come together like in a Julia Childs show. In February we were hondling and hip-checking them all towards reaching the finish line at the same time. The deadline came together nicely for March 8-9, 2018. We expected both of the gigantic retailers to bid, along with at least one of the two medium sized retailers.

In the last week of February, 2018 we received a letter from the SEC, asking for cooperation in an investigation they had started of the entire blockchain industry. It was reported in the press that 180 individuals across the blockchain industry received subpoenas the same week. We took some pride in the fact that we had not received a subpoena, but only a letter asking for our cooperation. Still, it mildly surprised me for another reason: given that we were already having an open and friendly relationship with the SEC (as I had repeatedly been assured by both an in-house tZERO executives and the outside lawyer from Jones Day), why was the SEC needing to write a letter to request our cooperation?

On March 1 we announced the SEC letter.

On March 5, the board of one of the giant Retailers met, and decided that they “could not make an offer on a firm that was under SEC investigation.”

The other giant firm did was such firms do: they began testing the auction we were running, asking for a delay of a few days, seeing if there was anyone else in the running or if they had dropped out…

The medium-size retailers said they were going to hold back, to come back to if none of the big guys made an offer….

And the soufflé collapsed.

I communicated immediately with Ms. Szczepanik that I wished to come see her. My interest, of course, was in getting the SEC matter resolved, and rescuing the soufflé. To my pleasure and surprise, the SEC was not only willing to meet with me, they were anxious to do it as quickly as possible, even the following week. So quickly, in fact, that my own lawyer was not ready, and while I was willing to go in to the SEC (again) without a lawyer, he convinced me to wait until he was available on March 28. This being the aforementioned Cliff Stricklin, a highly-esteemed former judge and federal prosecutor, I took his advice, but still, on March 28, we (along with Steve Obie, the outside lawyer from Jones Day who had been handling interactions with the SEC for those two years) were escorted into offices of the SEC in New York to meet with Valerie Szczepanik and Daphne Waxman, a younger attorney from (if I recall correctly) the staff of the Enforcement Division. On the television monitor there was someone from the Washington, DC office who had dealings with SpeedRoute, the smart-order routing firm upon which tZERO had been built.

With one exception (which I will get to), the meeting was both businesslike yet highly pleasant, professional, and cordial. Ms. Waxman had me move briskly through a variety of subjects regarding ownership structure, people involved, our intentions, how we were handling this, how we were handling that, peppering me with questions throughout. When the initial download of information was complete, it became more of a conversation, wherein they let me know (with a sincerity that I believed and still believe) that they were not trying to block the introduction of blockchain into capital markets, but felt that the SEC had a legitimate interest in overseeing its introduction. I agreed with them wholeheartedly, and insisted that it was my goal to continue working with them as a full partner in designing and building what was being built within tZERO. It was a superb meeting, and precisely the kind of relationship I had been dreaming that tZERO could have with the SEC, the relationship that I understood we needed to have if we were going to move forward. I could not have asked for a more positive meeting.

In fact, I not only got the impression they wanted us to go forward, I got the impression this regulatory body was (metaphorically) checking its watch and tapping its toes, asking, in essence, “How quickly are you going to be able to get all of this built?” I formed the hypothesis that their issue was the ICO market, which I had publicly said was likely 95% fraudulent (and that I was surprised the SEC had not started acting against). It was giving them heartburn, yet they could not really take action against people for doing things illegally (my hypothesis ran) until there was a way to do it legally: that is where we came in.

I repeat, that is a hypothesis only. However, I am confident that (whatever the reason) I read the room correctly, that it was them asking me to rush. So much so, in fact, they asked us how quickly we could deliver on all the document requests they had made in the letter they had sent several weeks earlier. I half-recall that they were asking if we could get it all to them within 30 days, or some extremely tight schedule such as that (I say “rushed” because the document production ended up being 1-2 million documents).

It was around this point, far into the meeting and only after all their questions had been answered, that I spoke up, and told them know that we were on the same page in that regard, and that they could expect no stonewalling from us. In fact…. I walked them through what had just happened a few weeks earlier, starting with the conversation with Buffett the previous August, the hiring of Guggenheim, the orchestration of the auction of the Retail business, the interest shown by two of the largest and most attractive retailers in America, how there had been backchannel talk of a $1 billion bid, and how the process had been on the point of coming off like clockwork on March 8-9… but then with the arrival and announcement of the SEC letter asking for our cooperation, the entire soufflé had collapsed. Thus, we were not only not interested in stonewalling them, we were interested in getting through everything as quickly as possible, and rescuing the soufflé. I asked them that if we could get the documents together in a matter of a month, could we count on them to review them within the same amount of time, and if they found no issues, give us a letter ending the matter, so that we could get on with the sale of Retail?

Both Ms. Szczepanik’s and Ms. Waxman’s eyes got big, and they looked genuinely horrified. For a moment I thought Valerie was going to agree to such a commitment. She caught herself, but after a moment’s reflection, said words to this effect: We hear you. The SEC is not in the business of destroying shareholder value. While it would be inappropriate for us to commit her to a specific timeline, let us assure you that we hear what you are saying, and we will ….. Well, let us just say we hear you, we understand what you are saying….. I believed and still believe she was 100% sincere as she said that. I actually think they felt quite badly.

The disconcerting aspect of the meeting was that I did not understand why some of the questions were being asked, given that we were already having (I understood) such a full and productive cooperative relationship with the SEC for the two years since Valerie had approached me at Cato. It seemed like we must be retreading a lot of work that had already been done. It was a head-scratcher, until the fellow from Washington spoke up over the teleconference and informed me that since my departure in 2016, the communication from the firm to the SEC had been…. 0. Nada. Nunca. Zippo. That meant that some people within tZERO, along with the Jones Day outside counsel, who had had repeatedly assured me that they had been working closely with the SEC, had been flatly lying to me. They had in fact been following the normal instincts of businesspeople, and stonewalling the feds. One of the liars (the outside counsel Steve Obie, of Jones Day) was in the room with us for this meeting, and though my blood pressure went through the roof, I refrained from flipping out at him in the room, and I regret to this day that I did refrain. For 18 months, every time I had asked him about how things were progressing with the SEC, he had looked me in the eyes and lied.

In any case, we left the SEC’s offices and the legal teams got to work producing what turned out to be (as I said) something like 1-2 million documents. Throughout the next two months the SEC was putting pressure on us to get it done. Because Steve Obie of Jones Day had been lying to me for 18 months about his cooperation with the SEC, I had begun transitioning leadership of our outside legal work to the superb Cliff Stricklin, of the fine firm Bryan Cave. Yet Jones Day was still handling the brunt of the work: I believe were 100 Jones Day lawyers working through the Memorial Day weekend of 2018 to finish up preparing the response to the SEC. tZERO spent, I believe, something in the high single digit millions to get that response completed, and by June, was shipping pallets of boxes over to the SEC.

Cliff had taken over as point man for all communication with the SEC (to the sullen protestations of Obie, of course, as he knew he had been found out). By July we were the ones checking our watches with the SEC. We had reason to believe that if we could get that letter from them saying that their enquiry into us was complete, we might just barely hondle the auction back into place, and save the soufflé (the large retailers were letting our banker, Andy Tussig, know how problematic the SEC enquiry was). In July we told the gigantic retailers who were interested in bidding that we were expecting resolution in August, or by Labor Day, and that we expected a clean bill of health from the SEC, and could then resume the auction process. Andy let us know that there was still strong interest from them in seeing that happen. Labor Day came, and no word from the SEC. September, and the soufflé continued its collapse. October…. November…. Still nothing from the SEC. Somewhere along the way, one of the large retailers walked.

In early December, 2018, the SEC sent us a letter that I am tempted to reproduce here (but knowing this might trip all kinds of legal protocols, I will refrain from doing so). Let me just state that it gave the strong impression that they had yet to open any of the boxes we had sent them six months previously, in June, 2018.

In late December, 2018 we got word that the SEC Enforcement Division had opened an investigation into our international dealings with GSR (as I described fully in “Sonny Wu is a Four-Flushing Cad (GSR)”). With all this uncertainty from the SEC (as our banker continually reminded us), one gigantic bidder had walked away completely, the other was coming out to Utah and calling, continually testing to see if they had any competition, the medium players were waiting to see if we got something done with one of the giants…The soufflé just kept collapsing.

There was a last gasp of the auction in December – January, 2019, but it was fizzling in February. Not completely: one never gets a note from the kitchen saying, “The souffle is collapsed.” In February or March of 2019 I was in Singapore (where I happen to be now), dealing with Makara Capital to get the GSR deal done, but taking telephone calls from the head of M&A of one of those two gigantic retailers, thinking we had a deal, but she kept testing …

In summary, I had spent 2018 trying to nurse a soufflé back to life. It came in a couple rounds, once in that August-September, and once as 2018 ended and into Q1 of 2019. I was repeatedly ready to announce that we were shutting down the sale process until we got the SEC issues resolved, but just as I prepared to do so, new parties would show up. By the annual shareholders meeting in May I thought it was time to formally shutter it, but just before the meeting two new parties made contact (one of whom is probably the best possible acquirer of Overstock Retail, as there is wonderful overlap in our categories and customer base, they have dramatically under-invested in their own website, and acquiring Overstock Retail would be a one-stroke way to save themselves about 10 years and a $1 billion in trial-and-error: I have 0 insight into how any of that has progressed since I left in August). But basically, over time, the soufflé turned to soup.

There is one detail I left out. Because in December of 2018 it was my GSR dealings that became the focus of the SEC Enforcement, in Q2 of 2019 I began looking into the people who handle international and cross-border enforcement matters for the SEC. It turns out that the SEC Enforcement Division Cross-Border Working Group is led a woman named, “Melissa Hodgman”.

Besides her remarkable career at the SEC, Ms. Hodgman has two other accomplishments worthy of mention:

Hours after Hillary Clinton’s emails were found on Anthony Weiner’s laptop, Ms. Hodgman was promoted to Associate Director and was immediately put in charge of the SEC team investigating the Clinton Foundation (and remember, as I indicated in my appearances on television in August, along with my information regarding Maria Butina I have information regarding “corruption of a federal official”).

2. Melissa Hodgman is (I shit-thee-not) the wife of Peter Strzok.

If only there were a pattern. Next up: a contest to see it. Prize = 1 Bitcoin