PHANTOM MENACE CEO Patrick Byrne is waging an EXTRAORDINARY CAMPAIGN against short-sellers. The hedge fund guys say he has underperformed. He says they are tools of a sinister "SITH LORD."

(FORTUNE Magazine) –

Even hardened denizens of Wall Street were shocked by a conference call that Patrick Byrne, the CEO of online retailer, held on Aug. 12. "I want to get something off my chest," Byrne announced. Then he launched into a rant about a "miscreants ball" in which he mentioned hedge funds, journalists, investigators, trial lawyers, the SEC, and even Eliot Spitzer. "I believe there's been a plan since we were in our teens to destroy our stock, drive it down to $6--$10 ... and even a plan for how the company would then get whacked up." The "designated final owner," who provided the "orchestration," was someone Byrne dubbed the "Sith Lord," a person he refused to identify other than to say that "he's one of the master criminals from the 1980s." And that's just the basic outline. There was more. As Mark Cuban, the billionaire investor, later wrote on his blog, "Never before in the history of Wall Street has a single conference call mentioned the following topics: miscreants, an unnamed Sith Lord he hopes the feds will bury under a prison, gay bathhouses, whether he is gay, does cocaine, both or neither, and an obligatory 'not that there is anything wrong with that,' phone taps, phone lines misdirected to Mexico, arrested reporters, payoffs, conspiracies, crooks, egomaniacs, fools, paranoia, which newspapers are shills and for who, payoffs, money laundering, his Irish temper, false identities, threats, intimidation, and private investigators. All in 61 minutes." Cuban is now short 20,000 shares of Overstock.

Patrick Byrne is from a family that is considered royalty in insurance and investing circles. His father, Jack Byrne, ran Geico, the auto insurer that was later purchased by Warren Buffett's Berkshire Hathaway, and is the former CEO of White Mountains Insurance. And yet Patrick Byrne, 42, has established himself as a maverick. For the better part of the past year he has been waging a war against critics of his company, from short-sellers to journalists, whom he often calls "hedge fund quislings" or "lapdogs." (I've had a minor scrape with him myself.) The day before that August conference call, his company and one of its shareholders filed a lawsuit against a well-known hedge fund called Rocker Partners; its two top executives, David Rocker and Marc Cohodes; and a research firm called Gradient Analytics, along with its two founders. In the lawsuit, Overstock alleges that the defendants "orchestrated a wide-scale predatory campaign of knowingly distributing false, and covertly biased, written reports about Overstock in order to disparage Overstock and enrich themselves."

All the parties named in the lawsuit deny any wrongdoing, and David Rocker says he is preparing a dismissal motion and countersuit. But the legal skirmishing is only one front in what has become one of the most remarkable and bitter wars between short-sellers and a company.

Rocker Partners has a short position in Overstock shares. Its executives say they believe that Overstock's business model is flawed and that its management has done a poor job. That's a pretty routine position for a short-seller to take: bet that a company's management team is weak or that its numbers don't add up, borrow shares to sell, and hope to buy them back later at a lower price.

Byrne's behavior has been so over the top that it would be tempting to dismiss it as a paranoid fantasy. Can you imagine the CEO of another company making a conference call like Byrne's without being sent packing by his directors? But Overstock's board is still backing him. It recently named his father to take his place as chairman, but Jack Byrne says of his son, "The board loves Patrick. There is no consideration whatsoever of asking Patrick to step down." The senior Byrne also says, when asked about what Patrick calls his "jihad," "I think he will be proven correct, one way or the other." Another board member, John Fisher, says, "Patrick is a business genius."

Byrne's campaign against his perceived enemies has even made him something of a hero to those who believe that short-sellers are the operators of Wall Street's ultimate black box, predators who destroy companies through innuendo, bullying, political connections--and sometimes through an illegal practice known as "naked shorting." "Those of you who are inclined to think that Patrick has gone off the deep end ... should pay close attention to the company he keeps," writes Tom Gardner of the Motley Fool on his website's message board. Gardner adds, "I know where I think the burden of proof resides."

Byrne says he's not out to save just himself, or even his company, but the entire system. As he wrote on a Motley Fool message board: "For many months I have gone to bed knowing somewhere in America there is a grandmother eating dog food tonight so that some ass ... on Wall Street can drive a new Porsche."

Patrick Byrne loves to tell a story about how he built, which bills itself as "Earth's largest discounter." In 1999 he bought a majority stake in the company, which had at its core a simple--and compelling--business model: to buy goods from distressed manufacturers, resell them to consumers at a fraction of their original retail cost, and still pocket a nice profit. (By way of example, in late October you could buy a DVD of Star Wars Episode III: Revenge of the Sith for $15.79, which says is a savings of 47%.) To finance his new business, Byrne turned to the Silicon Valley venture capital community. All 55 VCs he met with turned him down, so he funded the business himself. When the Internet bust came, Overstock liquidated the assets of 18 dot-coms funded by the very VCs that had previously turned Byrne down. Business boomed.

Byrne, who has a black belt in tae kwon do, is certainly a fighter. After graduating from Dartmouth, he was diagnosed with testicular cancer. In a speech in Boston in 2000 that drew several standing ovations, he described how he battled three bouts with the disease, the last of which his doctors said he wouldn't survive. He later told Charlie Rose, "In my 20s I was more or less an invalid," and yet he has accomplished extraordinary things in academics, athletics, and business. He got a Ph.D. in philosophy from Stanford and was a Marshall scholar. He bicycled across the country four times, and he has trained to be a professional boxer. In the late 1990s he served as the CEO of Fechheimer Brothers, a uniform manufacturer that is owned by Buffett's Berkshire Hathaway.

In the spring of 2002, Byrne took public, not via a traditional initial public offering but using a method called a Dutch auction, in which investors, not Wall Street bankers, set the price for the stock--a method later made famous by Google. Along with the venture capital story, it gave Byrne anti-Wall Street cred.

Overstock grew, fast--its revenues hit $40 million in 2001 and $92 million in 2002--and investors began to buy. Part of the lure was the promise of the business model. In a February 2000 story, Byrne told FORTUNE that his company "will make more money in the next five years than" Another part of the lure was Byrne himself. People were struck by his background and sheer smarts. "Byrne had a vision, an intense desire to make it happen," says Tom O'Halloran, a portfolio manager at Lord Abbett and at one time a large Overstock shareholder.

Which is not to say that everyone loved Byrne. In July 2003, when Overstock was selling for about $12 a share, a research firm called Camelback Research Alliance published a report that was skeptical of the company. Camelback, which was founded in 1996 by Donn Vickrey and Carr Bettis, both of whom are accounting Ph.D.s, criticized the quality of Overstock's earnings, identifying what it called "severely negative operating cash flow," and questioned the independence of its board of directors. In 2004, Camelback changed its name to Gradient Analytics.

In early 2004, Rocker Partners took note of Rocker Partners is a well-known short-selling firm that has been in existence for almost 21 years. (David Rocker's Milburn, N.J., office is full of bears--ceramic bears, stuffed bears, you name it.) Rocker and his partner, Cohodes, have been short some of the most notorious debacles of the past decade, including companies like Lernout & Hauspie, AremisSoft, and Krispy Kreme. Like other short-sellers, Rocker and Cohodes believe there is a moral rightness to what they do. "I'm not applying for sainthood. Our goal is to make money," says Rocker. "But our goal is also to get the bad guys off the Street."

Rocker, like Gradient, saw red flags at Overstock. Wasn't it just a classic dot-com, like the infamous Sure, it could grow like mad, but with gross margins that were lower than's, how would it ever make money? Rocker also noticed that Byrne had made predictions about revenues and earnings that didn't seem to materialize (despite his comment to FORTUNE, for example, Overstock was still losing money by early 2004). Rocker first shorted Overstock shares in February 2004, when they were trading at around 30.

For a while that looked like a very bad bet--2004 was a great year for Byrne and Overstock. In November, Overstock raised $70 million by selling stock and another $100 million through a convertible debt offering. Despite Byrne's rants about how corrupt the Street was, he did not do another Dutch auction, but instead used Piper Jaffray and Lehman Brothers. (Byrne says today that secondaries using Dutch auctions didn't work so well, and that Lehman "stuck out their hand to me.") After the offering, Lehman began to recommend Overstock's shares and put a target price of $90 on them. On Dec. 6, Overstock closed at $76 a share. Analysts said that 2004 was the last year in which the company would post a loss.

Even in that successful year, there were signs that Byrne was remarkably thin-skinned. In the fall of 2004, I wrote a FORTUNE story titled "Is Overstock the Next Amazon?" After the piece came out, Byrne sent me an e-mail saying "Fair. And balanced." Two days later he wrote another e-mail: "I actually thought it was crap.... So, why exactly did you become a reporter? Giving Goldman traders blowjobs didn't work out?" Around that same time, after Gradient released another report questioning board members' independence, Byrne wrote to Vickrey: "Donn, you make a living toadying to bully hedge funds ... you deserve to be whipped, f--d, and driven from the land."

Then, in early 2005, came the first truly weird moment. That was the conference call held at 8:30 A.M. on Jan. 28 to discuss its year-end results. At the end of the Q&A, a guy who gave his name as Bob O'Brien came on the line. "You, probably, the name is not familiar," he began. He went on to say, "I think I can explain what is going on with your stock and basically why so many people are saying mean things about you," and proceeded to outline a plot of what he called "criminal manipulation, allusions, fraud, libel"--and something called "naked shorting." At the end of O'Brien's speech, Byrne said, "I buy toasters and sell toasters ... I don't know any of the stuff you are talking about."

Everything about Bob O'Brien's performance was odd. First, you don't often hear outsiders spouting off about conspiracy theories on company conference calls. Second, Byrne and O'Brien seemed not to know each other, but Byrne himself would later say that "O'Brien contacted me in October" and began laying out his thesis. (Byrne explained in a Motley Fool post that when O'Brien said his name might not be familiar, Patrick "assumed" he meant that his name might not be familiar "to your audience.") And third, Bob O'Brien's name is not actually Bob O'Brien. He claims he has to remain anonymous because of threats to his safety. The New York Post has published a story saying it believes he is one Phillip Saunders, a small-business man who would be utterly uninteresting were it not for his cloak of anonymity and his baroque theories. In an e-mail message, O'Brien says, "I don't discuss my identity--given the number of organized-crime folks that have been connected to Wall Street and hedge funds, it seems imprudent."

A critical part of the conspiracy O'Brien outlined is something called "naked shorting," which involves a truly black-box part of the market. Ordinarily, when someone wants to short a stock, he is required by law to borrow actual securities first. In naked shorting a short-seller registers a trade without actually borrowing the shares. In theory this means that there is no limit on the pressure a short-seller could apply to a stock. The practice is illegal in most cases.

Bob O'Brien--and many others in his camp--claim that naked short-selling is rampant, and that it destroys both small companies and small investors. "Welcome, welcome to the greatest transfer of wealth from legitimate shareholders to the system set up for stock trading that's ever occurred," he writes in his blog.

Accusations of rampant naked shorting have been around for some time, although in the past three years they have gotten more exposure thanks to the Internet. O'Brien helped create a site called the National Coalition Against Naked Shorting, or NCANS (, whose executive director is a woman named Mary Helburn. Senator Bob Bennett of Utah, at a March 9, 2005, hearing of the Senate Banking Committee, told the panel that his constituents "feel victimized" by naked short-selling. Attorney John O'Quinn, who made his name winning billions for the state of Texas from the tobacco companies, claims that naked shorting has bankrupted many companies. His firm has filed more than two dozen lawsuits against Wall Street firms in seven states.

Patrick Byrne quickly became a card-carrying member of this movement. On Feb. 8, 2005, an NCANS ad was featured prominently in the Washington Post. "Naked short-selling ... is literally stealing money from the widows, retirees, and other small investors," the ad warns. Byrne later said, "I paid for that," and also that "I largely wrote the ad."

Naked short-selling makes for great conspiracy theories because it is so difficult to disprove--in fact, many on Wall Street agree that it happens to some degree. But there are two old maxims on the Street: One, you can't destroy a fundamentally healthy company through market manipulation--push the stock low enough, and someone will step in and buy it. And two, if a company begins to complain about short-sellers, watch out, because something else is very wrong. As Cohodes puts it: "We've been short a lot of stocks in our lifetime. We've been right a lot, and we've been wrong a lot. But when we get our butts handed to us is when management focuses on running the business."

In the same conference call in which Bob O'Brien gave his unusual perspective, Overstock reported revenues of almost $500 million for the year, and said that it had made money in the fourth quarter of 2004. Even so, the stock fell almost 20% that day. So is the stock's decline evidence of a conspiracy? Or could it be due to legitimate concern about's business?

To Byrne and of course O'Brien, the answer is clear. O'Brien wrote in his blog: "The whole thing looked suspiciously familiar--bashers flooding the boards, a company that was originally expected to have a negative earnings number came out with 12 cents a share earnings vs. an 8-cent whisper number, and the stock was trampled in after-hours trading." The skeptics, though, saw something else: weak cash flow and a troubled balance sheet. And they noted that customer acquisition costs had soared.

That winter Byrne's worldview seemed to get darker. Instead of simply lashing out at critics, he implied that they were corrupt. For instance, on Feb. 15 he identified "Camelback, Greenberg, and other journalists" as people who "seem to go out and trash companies David Rocker is short.... How do I know this? Someone close (remarkably close!) to a guy mentioned above described it all to me, right down to the number of times per week phone calls are made amongst Donn [Vickrey], Herb [Greenberg, of Dow Jones Marketwatch], and David Rocker.... I am by no means suggesting that the remarkable coincidence of these journalists' attacks with Rocker's short positions means that they are on the take: There are many possible explanations for the coincidence (including, for example, that they could all be right, I COULD be a crook, and they all figured it out at the same time.)" Journalist Greenberg by that point had written a number of skeptical stories about Overstock. Byrne told Greenberg that one explanation for his skepticism could be that "you are on the take, and get paid off somewhere in order to do hatchet-jobs-to-order."

During 2005 the stock continued to slide, and Byrne continued to air his views. But perhaps nothing illuminates the growing strangeness surrounding Overstock better than an incident involving an Overstock senior vice president named Stormy Simon. Through the gossip mill, David Rocker heard that she was unhappy. So he got word to her that she should call him. Simon was working up the nerve to call Rocker--but it wasn't because she had anything to share. Byrne wanted to see what Simon could learn--he had grown concerned because, he says, he had heard that former employees were being paid to divulge information about Overstock. ("It's called a dangle," Byrne said recently.)

Simon's phone rang while she was in her office in Salt Lake City with Byrne. She put Rocker on the speakerphone so that Byrne could listen and told Rocker that she was in Philadelphia, close to his New Jersey office. They agreed to meet the following morning--she had to take the redeye to Newark to make the appointment. Simon told Rocker that she was "feeling very alone" because she was a single mother with two kids, but that she could "sink Byrne, I can sink his ship today." ("She showed him some thigh," Byrne says.) Rocker wasn't sure whether to believe her. He told her that if she had valid concerns, she should get a lawyer and should take them to the SEC.

Simon says now, "I believe in Patrick Byrne. He's brilliant, probably ten steps ahead of the rest of us."

Today Overstock's shares are selling for about $34, down from a peak of $76. Although the company lost money in the first three quarters of this year, Byrne says that he is choosing to grow fast rather than to make money. "You tell me when you want me to stop growing at 80% to 100% per year; I'll tell you when we can get profitable," he told CNBC. In a Charlie Rose appearance in the spring of 2005, he said, "We're basically running at about breakeven, and we're growing at 100% a year," and added that he wanted to double each year--from $1 billion in 2005 to $2 billion to $4 billion--though he said "at some point reality is going to say you can't grow that fast anymore."

Byrne can make you wonder why anyone doubts him. And yet when you talk to people who have sold their positions and listen to analysts who used to have buy ratings on the stock--which only one out of 13 does today--you realize that the company has not delivered what investors expected. Even Craig Bibb, an analyst at WR Hambrecht who has the lone buy rating on the stock--there are four sell ratings--cites Overstock's "hugely missing earnings expectations" as a reason for the stock's decline. Indeed, at the beginning of this year the analysts were predicting that would make 37 cents in 2005. Today the consensus earnings estimate is for a loss of 59 cents.

Onetime believers see other warning signs. Tom O'Halloran of Lord Abbett, who bought a large stake in February 2004, has sold most of it. "Many others have cut way back or bailed entirely, which in and of itself is a warning sign," he says. Another hedge fund manager who owned a stake in Overstock sold it after the O'Brien conference call--and began shorting it after the Sith Lord call. The biggest holder today, beyond Patrick Byrne and his family, who have been buying stock, is a California hedge fund called Scion Capital, which purchased a 6.95% stake in September. One of Scion's part owners is White Mountains Insurance, Jack Byrne's old company.

Certainly the third-quarter results, announced on Friday, Oct. 28, were not cause for optimism. Once again lost far more than analysts were expecting. "Q3 was rough. My bad," Byrne said. He added, "Some will criticize me for taking my eye off the ball to pursue a jihad." But it is the fourth quarter, which includes the all-important holiday season, that will be proving time. "I'm holding this at a low level because I continue to get red flags," says O'Halloran. "But I know there is huge upside if they come through." No one disagrees about that. Says one major short-seller: "If he were able to make his numbers, the stock would soar and the longs would score a touchdown and the shorts would lose massively."

If you look for clues to the Sith Lord's identity in the lawsuit that has filed against Rocker and Gradient, you won't find any--there's no mention of him. You won't find any mention of naked shorting either--even though one plaintiff is none other than Mary Helburn of the National Coalition Against Naked Shorting, and the most prominent of Byrne's lawyers is John O'Quinn. In a recent e-mail to me, Byrne even said that he "was not blaming stock performance on the blackguards." When I asked how that could be, given that the first page of the suit says that "Defendants' actions caused substantial harm to Overstock in the form of decreased market capitalization," he responded that "it is grossly simplistic to say ... that we are blaming them for stock performance."

Byrne also says today that he has never linked Rocker's behavior to the naked shorting of And it's true that he hasn't explicitly done so. But in a recent conversation Byrne said that Rocker is connected to naked shorting--although Rocker himself may not know it. He is "at the bottom of the food chain," says Byrne, and it is the discovery in this lawsuit that "gets us up the food chain." Then he says that the "food chain" is not the right metaphor, but rather al Qaeda--"There's no office, no headquarters; it's a splintered group that has learned to operate together." In a recent Motley Fool post, Byrne had this to say: "I have thrown out a lot of 'stuff.' By and large I can substantiate my stuff but am simply choosing not to now.... I am perfectly comfortable leaving it to the public to decide if I am bluffing or not."

It is hard to pin Patrick Byrne down, and not just because of his verbal dancing. From a distance he seems like a bully, accusing people who depend on their reputations of corruption. The time is rapidly approaching when he will have to deliver--both the numbers to prove that the business can make money and the facts to prove that the Sith Lord exists.

And yet in person he is a much more sympathetic character. When he apologized to me for the e-mail that he sent--it was prompted, he said, by the "smirky" way I had discussed his cancer--tears came to his eyes. He is very smart, and he has loyal backers. But he seems like someone who sees shadows on the wall that are much bigger than the characters who cast them. Maybe the Sith Lord is actually Patrick Byrne himself--because he has become his own worst enemy. Nietzsche said it best: "Whoever fights monsters should see to it that in the process he does not become a monster."