Dismissal of Suit against Goldman Sachs over eToys IPO Affirmed on Appeal
Adam Brown | Bloomberg Law
The Appellate Division of the Supreme Court of New York, First Department, affirmed a lower court ruling dismissing fraud and breach of fiduciary duty claims against Goldman Sachs & Co. in connection with the bank’s role in underwriting the $178 million initial public offering (IPO) of the now-defunct online toy retailer, eToys, Inc.
Goldman Hired as Lead Underwriter
In 1999, Goldman agreed to serve as lead managing underwriter for eToys’ impending IPO. Upon Goldman’s recommendation, eToys ultimately priced its IPO at $20 per share but made shares available to Goldman at $18.65 per share. On May 20, 1999, the day the stock began trading, the share price fluctuated between $71 and $85. After three days, the average trading price dropped to $48.13, and by mid-February 2000, the average trading price had sunk to $16.95. Thereafter, the shares never traded above the original $20 offering price. In March 2001, eToys filed for reorganization under Chapter 11 of the Bankruptcy Code.
The U.S. Bankruptcy Court for the District of Delaware granted the Official Committee of Unsecured Creditors of eToys permission to prosecute claims on behalf of eToys and the bankruptcy estate. Thereafter, the Committee commenced an action against Goldman for breach of contract, fraud, professional malpractice, unjust enrichment, and breach of fiduciary duty in New York state court. Goldman, in turn, moved to dismiss the complaint. The trial court granted the motion with respect to the first four claims but granted plaintiff leave to replead the fraud claim. With respect to the fiduciary duty claim, however, the court denied the motion, holding that, while the underwriting agreement did not establish a formal fiduciary relationship, the complaint “sufficiently raise[d] an issue as [to] the existence of an informal one.”
On appeal, the First Department affirmed the ruling with respect to the fiduciary duty and fraud claims but reinstated the other three claims. That decision, however, was reversed on appeal to the New York Court of Appeals, which reinstated the trial court ruling dismissing all but the fiduciary duty claim with leave to replead the fraud claim (EBC I).
Plaintiff subsequently submitted an amended complaint repleading its fiduciary duty and fraud causes of action. With respect to the fiduciary duty claim, plaintiffs asserted that:
Goldman served as eToys’ fiduciary because eToys reposed great trust and confidence in Goldman in the pricing of the IPO and provided to this underwriter confidential information. Goldman exercised effective control over the pricing of the IPO. eToys placed utmost reliance on Goldman and accepted its recommended IPO price.
Goldman then moved for summary judgment on the remaining claims. The trial court granted the motion, and plaintiffs appealed.
Goldman Owed No Fiduciary Duty
On appeal, the First Department focused initially on the scope and language of the parties’ underwriting agreement, noting that Goldman’s discounted share price was included as an express term in the agreement. Moreover eToys’ prospectus stated that the two parties had “negotiated” the offering price for the common shares in light of prevailing market conditions. In light of eToys’ obligation under the Securities Act of 1933, 15 U.S.C. § 77a, to disclose the material facts which led to the offering price, by using the term “negotiated” eToys impliedly acknowledged that its relationship with Goldman was the product of arm’s length negotiations. The nature of their relationship was further evidenced by the fact that, while Goldman had an ongoing relationship with eToys’ securities counsel, Venture Law Group (VLG), the firm promptly notified Goldman at the inception of the IPO process that it would be representing eToys in the IPO and “would be providing advice to eToys that is adverse to Goldman Sachs.” (Internal quotation omitted.) Thus, the Court held that in the absence of fraud, the “arm’s length negotiation of the offering price negate[d] plaintiff’s claim that it was the subject of advice given by Goldman Sachs as fiduciary.”
Moreover, the Court explained that because the IPO was structured as a firm commitment, whereby the underwriter must purchase the entire offering then bear the risk of loss on any unsold shares in the secondary market, Goldman “had an inherent interest in limiting its exposure by negotiating for a lower offering price.” Thus, the parties’ relationship was adversarial from the start, a fact which, according to the Court, also negated any possibility that the underwriting agreement established Goldman as eToys’ fiduciary: “It is well settled that a fiduciary relationship ceases once the parties thereto become adversaries. A fortiori, a fiduciary relationship cannot have been created between parties who have been adversaries throughout their transaction.” (Internal citation omitted.)
The Court acknowledged that the Court of Appeals in EBC I had ruled that a fiduciary relationship may arise if the parties had “an advisory relationship that was independent of the underwriting agreement.” Thus, plaintiff’s fiduciary duty claim survived the pleading stage because it alleged that “the parties . . . created their own relationship of higher trust beyond that which arises from the underwriting agreement alone, which required Goldman Sachs to deal honestly with eToys and disclose its conflict of interest.”
The First Department held, however, that plaintiff’s allegations, sufficient as they may have been for purposes of surviving the pleading stage, were insufficient to survive the instant summary judgment motion. Plaintiff’s assertion that Goldman served in an advisory role separate and apart from its role as lead underwriter was belied by plaintiff’s discovery responses in which it acknowledged that no formal advisor-advisee relationship had been created. Instead, eToys was merely relying on Goldman’s informal advice and general expertise in bringing companies public. Noting that “advice alone . . . is not enough to impose a fiduciary duty,” the Court held that plaintiff failed to establish that the parties’ relationship created a fiduciary duty which transcended the underwriting agreement.
Moreover, even assuming such a fiduciary duty existed, the Court observed that plaintiff failed to establish an issue of fact as to whether Goldman breached that duty. The conflicts of interest alleged by plaintiff were based on Goldman’s practice of ensuring that its larger institutional clients and private wealth investors receive IPO share allocations as a quid pro quo to encourage future trading business. The testimony of various eToys executives, however, established that eToys was well-aware that underwriters generally offer IPO shares to their most valued customers. As a result, plaintiffs’ allegations were insufficient to create an “issue of fact as to whether Goldman Sachs had undisclosed conflicts of interest” based on its failure to disclose its allocation arrangements with customers.
The Court also rejected the bases for plaintiff’s fraud claim. To the extent that the claim was based on Goldman’s failure to disclose its allocation arrangements, the claim failed for the same reason plaintiff’s breach of fiduciary duty claim failed. As for the remaining bases, the Court held that, while the complaint alleged that Goldman’s statement “that its pricing represented the fair value of the Company’s Common Stock” was materially misleading, such a statement amounted to nothing more than “nonactionable opinion.” And plaintiff’s assertion that Goldman fraudulently promised that eToys shares would be allocated to long-term institutional investors, rather than to known “flippers,” was devoid of any evidentiary support and, in fact, belied by contrary evidence in the record.
Dissent: Issues of Fact Remain
Judge Sheila Abdus–Salaam penned the lone dissent, stating that the majority mistakenly relied exclusively on the terms of the underwriting agreement. As a result, its decision “[ran] afoul of the Court of Appeals’ recognition that an advisory relationship independent of the underwriting agreement would be demonstrated upon proof that eToys was induced to and did repose confidence in Goldman Sachs’ knowledge and expertise to advise it as to a fair IPO price and engage in honest dealings with eToys’ best interest in mind.” (Internal quotation omitted.) Judge Abdus-Salaam observed that the record did provide some proof that Goldman may have served in an advisory role and may have been the driving force behind the ultimate pricing of the IPO. As such, “the majority improperly engage[d] in issue determining rather than issue finding when it conclude[d] as a matter of law that there was no fiduciary relationship.”
Similarly, Judge Abdus-Salaam believed that issues of fact also remained with respect to plaintiff’s assertion that Goldman breached its fiduciary duty by failing to disclose its conflicts of interest and misrepresenting that it intended to issue IPO shares only to long-term investors. In light of the evidence in the record suggesting the eToys relied on Goldman’s pricing advice without any knowledge of Goldman’s allocation arrangements with its customers, Judge Abdus-Salaam opined that resolution of these issues should have been left to the trier of fact.
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