EToys Sues Goldman Sachs Over IPO

In what may be the first legal action of its kind, bankrupt dot-com eToys has sued Goldman Sachs, claiming the banking giant intentionally undervalued the e-tailer’s 1999 initial public offering and paved the way for its eventual failure.

The company claims Goldman knew eToys’ shares were worth more than the US$20 each it priced them at in May 1999. On its first day of trading, the e-tailer’s stock price more than quadrupled, peaking at $85, with 13 million shares trading hands.

The company also claims that Goldman received kickbacks from clients who benefited when the shares skyrocketed.

EToys raised $166 million from its IPO but was forced to declare bankruptcy less than two years later. The company is now operating under bankruptcy protection as EBCI Inc. and is trading as a Pink Sheets stock valued at a penny per share.

Cause and Effect

The undervalued IPO eventually led to eToys’ demise, according to the lawsuit, which seeks to represent the unsecured creditors, who received nothing when the company’s assets were sold in bankruptcy court.

“EToys incurred hundreds of millions of dollars in damages and eventually had to declare bankruptcy as a result of Goldman Sachs’ illegal conduct in underpricing the IPO and in receiving kickbacks,” said Stanley Grossman of New York-based law firm Pomerantz Haudek Block Grossman & Gross.

Grossman, the lead attorney on the case, told the E-Commerce Times that it has long been known that preferred clients of underwriters stand to profit handsomely from IPOs.

“What’s not been known is that underwriters were receiving a kickback,” he said.

Grossman added that the plaintiffs intend to gain access to “the book,” which underwriters use to track preorders for a stock and gauge interest before pricing an offering, as well as to other records related to the eToys IPO.

One of a Kind

While scores of tech shareholders have filed lawsuits based on similar claims during the past two years, the eToys suit appears to be the first one brought by a company that went public.

Most earlier lawsuits alleging impropriety in the IPO process — including one pending against eToys — name both the company that went public and the underwriter as defendants.

Priceline.com, Expedia.com, Buy.com and Drugstore.com all have been named in shareholder lawsuits in connection with their initial public offerings.

Pomerantz is the lead law firm on dozens of suits, including those against GoTo.com, the Internet Capital Group and e-commerce software concern PurchasePro.

Search for Blame

EToys failed because it lacked capital to continue operations, first causing it to be delisted from the Nasdaq exchange and eventually forcing it into bankruptcy after several rounds of layoffs.

Even the 2000 holiday season was not enough to save eToys. It began to show signs of collapse shortly after that period, cutting 700 workers in January 2001.

Presumably, more money raised at the outset might have helped the e-tailer to survive a bit longer. After all, the eToys brand has proven valuable to KBToys, which bought the bankrupt company’s assets and inventory at auction for $8.7 million and has used the recycled domain name to boost its share of Web traffic.

Grossman noted that eToys was different from many failed dot-coms.

“It had a really great concept,” he said. “It had an actual business model that made sense, not just some pie-in-the-sky idea. The problem was capital, and if they had additional cash they might have had the chance to hang on and become profitable.”

Signs of Woe

But some analysts believe the company’s days were numbered anyway, as brick-and-mortar chains figured out the best approach to selling online.

“Traditional retailers like Wal-Mart and Toys ‘R’ Us were poised to surpass eToys anyway, in the long run,” Forrester Research analyst Seema Williams told the E-Commerce Times.

The lawsuit echoes the dot-com stock boom, when IPOs regularly saw astronomical first-day gains, and comes as a slow but steady revival in the IPO market appears to be under way.

Earlier this year, online payment company PayPal debuted and has continued to trade at more than twice its offering price. On Thursday, DVD rental concern NetFlix went public and saw its stock jump from $15 to $16.75.