Yesterday, I blogged about the Overstock.com suit that has had some success in California state court.  This suit alleges that a short-seller and an "analytical reporting service" conspired to issue false reports to drive down the share price of Overstock.com and profit from the difference.  Gradient, the reporting service, kept a list of companies that suffered a 20% or more price decline after the issuance of its negative reports and used this list to recruit other customers who could request such reports.  The complaint alleges, among other things, libel.  As you may expect, the financial reporting on this case has centered around the free speech element.  If this case results in a judgment against the defendants, then how will bona fide stock analysts and financial reporters know where to draw the line between pointing out negative flags at publicly-held companies and libel?  (Mike McKee has two articles in The Recorder here and here.)

Bethany McLean, for example, dismissed the Overstock.com suit as "paranoid fantasy" in a November 2005 Fortune article.  Of course, McLean may be predisposed against lawsuits that name analysts and journalists who speak negatively about public companies.  Remember that McLean wrote a seminal article in Fortune (Is Enron Overpriced?) in March 2001 that is often cited as the article that began to unravel the Emperor's New Clothes (or New Financial Statements).  However, two things probably distinguish McLean's type of financial reporting from Gradient's.  The first, and most obvious, is that McLean had no direct interest in Enron's stock going down.  We know of no economic interest she held by way of owning or shorting Enron stock.  Therefore, it would be hard to show malice on the part of McLean for anything she said about Enron.  Furthermore, I would assume that McLean could back up her financial analysis.  In the Overstock.com case, the court went over many statements in the Gradient report that were simply false:  False facts about Overstock's business model and false conclusions that certain practices were not in accordance with GAAP.  Gradient's defense is that these were opinions.  However, the court made clear that merely saying "I am of the opinion that" before stating a verifiable fact or a verifiable conclusion is not an opinion.  If an analyst says that a business practice does not conform to GAAP, but that practice obviously does and is backed up by opinions from accountants and outside attorneys (no hoots here), then that is not merely an opinion.

Instead of rallying around the flag of free speech, I would think that reputable analysts and reporters would condemn this type of scheme.  (By the way, Gradient's reports were prepared by college graduates with no additional schooling or licensures; they were not CPAs or other licensed financial professionals.)  Gradient's reports make all analyst reports look suspect and biased.  In this age of "no analyst conflicts," there should be more policing of one's own.  (Again, legal documents in this case are collected here.)

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