M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Sunday, March 10, 2013

eToys and the rigged IPO game

Joe Nocera in the Times today unearths some Goldman emails about the eToys IPO from the dotcom era.  eToys raised $164 million in a 1999 IPO and then subsequently failed.  The story is familiar by now.  The IPO was underpriced and Goldman spun shares off to preferred clients.  After the company failed, creditors sued. It's emails produced in connection with that suit that Nocera uncovered.  The emails and creditors raise an important question:  who was Goldman working for during the IPO?

The plaintiffs charge that Goldman Sachs had a fiduciary duty to maximize eToys’ take from the I.P.O. Instead, Goldman purposely set an artificially low price, so that its real clients, the institutional investors clamoring for the stock, could pocket that first-day run-up. According to the suit, Goldman then demanded that some of those easy profits be kicked back to the firm. Part of their evidence for the calculated underpricing of eToys, according to the plaintiffs’ complaint, was that Lawton Fitt, the Goldman executive who headed the underwriting team and was thus best positioned to gauge the market demand, actually made a bet with several of her colleagues that the price would hit $80 at the opening.

If you are interested in learning more about this kind of thing, Sean Griffith has a good article on the practice of spinning in IPOs that appeared a couple of years in the Brooklyn Law Review. 



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You may recall that the underwriters of IPOs, particularly IPOs of tech companies that, like eToys, subsequently failed, were also sued for overpricing those IPOs by purchasers of shares who bought and held. Many of those investors claimed that the underwriters owed them fiduciary duties as well. A conclusion that the underwriters breached a fiduciary duty to the issuers by not pricing the IPO higher and breached a fiduciary duty to investors by not pricing the IPO lower would place the underwriters in an untenable position and consequently supports the conclusion that the underwriters owed a fiduciary duty to neither and were properly fulfilling their roles as financial intermediaries between buyers and seller by trying to price the IPO at a price that they reasonably believed reflected the long term value of the stock and the possibility that the company might fail (see the risk factors prominently disclosed in the IPO prospectus) rather than where the stock might trade in the first few days of trading based on the irrational exuberance of a limited number of investors.

As a law school professor, you might consider whether a balanced analyses should also reflect the judicial findings of fact and legal conclusions of the NY Supreme Court, Appellate Division (EBC I, Inc. v Goldman Sachs & Co., NY Supreme Court, Appellate Division, First Department, NY Slip Op 08839, December 8, 2011), rather than focusing on the views of a reporter, arguably focused on presenting a one-sided version of the facts to burnish his reputation as an investigative journalist (by uncovering publicly available documents!) in an effort to sell more newspapers. The practice of spinning may be unattractive to many, but it does not necessarily imply that underwriters breached a fiduciary duty to anyone with respect to the pricing of the IPOs.

For example, see the following quote from the Court's decision in eToys:

"According to the complaint, Goldman Sachs's undisclosed conflicts of interests stemmed from its practice of allocating IPO shares to large institutional customers and private wealth investors for the purpose of enhancing future trading business with them. We find no issue of fact as to whether Goldman Sachs had undisclosed conflicts of interest on the basis of the following evidence given by eToys' executives: —Lenk's testimony that he knew that Goldman Sachs did business with many large institutions and wealthy customers that would receive IPO allocations;— testimony by director Tony A. Hung that he knew Goldman Sachs had to have its investor clients' interests at heart and that it would give allocations to institutional and private wealth customers;— testimony by Senior Vice President Stephen Paul that from his familiarity with the IPO process he "knew that underwriters allocate shares to institutions that generate significant commissions, and also to high-net-worth individuals affiliated with companies that may have been, or could become, investment banking clients and that this would happen with eToys' IPO"; and— director Peter C.M. Hart's affidavit in which he states that based on his experience and observations over the course of his career in business and investments he was aware "that brokerage firms like Goldman Sachs allocate valuable resources to their most valued customers" and that a " hot' IPO allocation was a potentially valuable and scarce resource that Goldman Sachs would distribute among its valued customers, taking into account those customers' overall levels of business or potential business with Goldman Sachs."

On the basis of the foregoing testimony and affidavit, we find that the fraud cause of action was properly dismissed to the extent that it is based on Goldman Sachs's alleged failure to disclose its compensation arrangements with its customers. Based on the same proof, considered in light of the prospectus and the underwriting agreement, we find no issue of fact as to whether Goldman Sachs assumed a fiduciary duty to advise eToys with respect to its IPO price. We therefore need not consider whether such a duty was breached. Were we to consider the issue, we would find that Goldman Sachs met its burden of establishing that there was no breach.

In January 2002, four months before plaintiff commenced this action, Lenk gave the [*6]following testimony before the Securities and Exchange Commission:

"A.Let me give you some basic math here. At the $20 price, the company was valued at $2.4 billion. So Goldman did — from our perspective, Goldman did a great job. A lot of times historically, banks have been criticized for underpricing IPO's. You cannot criticize our underwriters for underpricing our IPO. They got us, you know, a $2.4 billion valuation. They did a great job in getting the price up and maximizing the proceeds of the company which we were grateful and happy for. Because they gave us the proceeds to try and grow and achieve our vision . . .

"Q.And was there ever a discussion of bringing the price of the offering above $20?

"A.I don't recall that. From a tactical perspective, what the banks would tell us was they liked to price IPO's between ten and twenty dollars a share. They don't like to be below ten. They don't like to be above twenty. And, ideally, they want to be in that — and I don't know — you, know I think it's sort of a practice in the marketplace. They like to have them priced between ten and twenty. You know, at ten to twelve, and moving up to eighteen and twenty and then twenty, we were raising double proceeds we initially thought. We were very happy strategically as a company to be able to have that extra cash. I don't recall us ever talking about going up to the higher price.

"Q.Yeah . . .

"A.As a CEO, I was scared to death of just living up to the $20 price. I was scared to death. We got [sic] to try to justify valuing the company. "There's only one thing worse than falling after the first day spike, it's falling below the IPO price. So how am I going to manage this company to be worth $2.4 billion, which was the $20 price."If we had talked about going higher, I would have said, No — I would have opposed that because I was already scared as it was."[FN2][*7]

Lenk's testimony refutes the pivotal allegation that eToys had been duped into underpricing its IPO shares. Similar statements regarding Goldman Sachs's performance were made in the affidavits of four of eToys' directors and the depositions of CFO Schoch and two other senior officers."

A legal blog should provide a more balanced perspective.

Posted by: KM | Mar 10, 2013 10:18:36 AM

This is just the tip of the story.

My entity (CLI) was the court appointed fiduciary (to maximize returns at a minimum of expense).

The attorney in Delaware for Goldman Sachs has already confessed to lying under oath to the Chief Bankruptcy justice in the eToys case (01-706).

Additionally, the counsel for Goldman Sachs in Delaware also (furtively) represents Bain Capital.

Our eToys case, who I am, the fraud on the court, by officers of the court that was perpetrated (admitted "intentional") via more than 30 erroneous Rule 2014 Affidavits.

Was NEVER properly investigated and/or prosecuted;
because of the "other" (retroactiv) secret.

A partner of the eToys Debtor's counsel law firm, from 1999 to August 2001; became the United STates Attorney on August 2, 2001.

Then the CEO of Bain Capital resigns and, two weeks later, announces his run for Governor of Massachusetts.

He who has ears to hear and eyes to see;
the comments "are" the retroactive secrets.

Which "may" bring down two monopolistic, ruthless empires. (BC and GS).

[That is, of course, if we live in a legitimate world; which USAG Holder stipulated {correctly} - that we don't].

Posted by: Laser Haas | Mar 10, 2013 4:44:21 PM

BTW, the story made it on the major Law networks too;
(in case KM wishes to bark at them for "re-telling".

Here's the LexisNexis link;

MORE importantly, as I did reflect this is jst the "tip" of the proverbial iceberg. Here's a late breaking on other Federal cases on price "Rigging" - which is apropos (in many ways).

Posted by: Laser Haas | Mar 14, 2013 6:37:51 PM

There's about to be a BIG BREAK in our eToys debacle.

Stay Tuned!
(and thanks for helping by posting the history).

Posted by: Laser the Liquidator | Jul 5, 2013 12:40:56 PM

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