When Goldman Sachs served as lead underwriter for the eToys IPO in 1999, a dispute subsequently arose as to whether Goldman Sachs had a fiduciary relationship with the issuer, and whether it had violated that obligation by its actions while bring the company public. The case was on appeal, and the current ruling, issued by an Appellate Court panel,  affirmed the dismissal of a lawsuit against Goldman Sachs by creditors of the failed Internet start-up eToys Inc. - a 4-1 split decision , which in everyone's books is a win.  Goldman had been accused of advising eToys to underprice its IPO and failing to disclose conflicts of interest. In EBCI Inc. v. Goldman Sachs & Co., 601805/02, ... the appellate court panel voted 4-1 to uphold Manhattan Supreme Court dismissal of the case on the grounds that there was no fiduciary relationship between eToys and Goldman. The conflict began in 1999, when Goldman acted as underwriter for eToys' IPO.  The stock went public at $20 a share, then prices soared that first trading day - between $71 and $85.  Within 3 days, however, share price began to fall and, by early 2000, the price fell below its IPO price of $20 - and it never recovered. By March 2001, the shares were nearly worthless, and eToys filed for Chapter 11 bankruptcy.  Its creditors were given authority to pursue legal action on its behalf.  So, in 2002, they sued Goldman, alleging the following:

• in addition to acting as underwriter, Goldman had advised eToys about the IPO and should have advised the company to price its shares higher so the company could have raised more cash through the IPO.
• Goldman did not disclose agreements it had to sell the stock to new institutional clients.
• Goldman committed breach of contract, malpractice, unjust enrichment and breach of fiduciary duty.

Goldman moved to dismiss, and the NYS Supreme Court Judge Bransten dismissed all but the breach of fiduciary duty claims, which the appellate court then reinstated in 2004. The Court of Appeals partly reversed, dismissing the three claims again in 2005.  After discovery and depositions, the judge granted summary judgment against the creditors - she held that the relationship between eToys and Goldman consisted only of the underwriting contract, which was negotiated at arm's length, and was not a fiduciary relationship. The creditors appealed. Appellate Court (First Department) Opinion. Writing for the Panel Majority, Justice DeGrasse wrote that they agreed with the initial judge's reading of the evidence:   "[W]e 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." Justice DeGrasse added that the allegation that Goldman had advised eToys to undervalue its shares was not credible, pointing to a statement by the company's former CEO, Edward C. Lenk, that he "was scared to death of just living up to the $20 price."

In dissent, Justice Abdus-Salaam said that other testimony given by Mr. Lenk created a material question of fact as to whether there was a fiduciary relationship. She noted that the Court of Appeals had found that there could be a fiduciary relationship in addition to the underwriting contract.

"While the majority states that it has examined the scope of the underwriting agreement to determine whether the parties had a fiduciary relationship that transcended the agreement, the majority's analysis essentially hinges solely on the language of the agreement, which conceededly does not set forth a fiduciary relationship."

"This analysis runs 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.'"

"Because the record presents proof on this very subject, the majority improperly engages in issue determining rather than issue finding when it concludes as a matter of law that there was no fiduciary relationship."

For further details, go to:   [New York Law Journal, 12/9/11]