(CN) - The New York Supreme Court Appellate Division has thrown out claims that investment bank Goldman Sachs underpriced an eToys Initial Public Offering of more than 9 million shares of stock.
     In a 4-1 decision, the court affirmed Supreme Court Justice Eileen Bransten's ruling in favor of Goldman Sachs, rejecting eToys claims for fraud and breach of fiduciary duty. The internet start-up had argued that Goldman failed to disclose conflicts of interest arising from its practice of allocating IPO shares its large valued investors "for the purpose of enhancing future trading business with them."
     After the first day of trading in the summer of 1999, eToys stock traded as high as $85 per share. Within three days, however, stock had declined to below $49 a share. By early 2000, the firm's stock was in free fall and never climbed above its $20 per share offering price. In March 2001, the company filed for bankruptcy and was acquired by Toys "R" Us in 2009.
     But Judge Leland DeGrasse said the parties had "adverse interests" and eToys executives, including CEO Edward Lenk, "knew that Goldman Sachs did business with many large institutions and wealthy customers that would receive IPO allocations" and that they were aware that Goldman had "its investor clients' interests at heart."
     "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," DeGrasse wrote.
     The judge cited Lenk's testimony to the SEC just months before eToys sued Goldman Sachs in 2002. In that testimony, Lenk said that Goldman "did a great job" valuing the company at $2.4 billion, or $20 per share.
     "Lenk's testimony refutes the pivotal allegation that eToys had been duped into underpricing its IPO shares," the ruling states. "Lenk's deposition does not materially contradict his SEC testimony that he would have categorically opposed any increase in the offering price."
     eToys also claimed that Goldman had allocated IPO shares to investors who flipped stock to turn a quick profit. But DeGrasse found that Lenk was aware of these "flippers" and that there was "no triable issue of fact as to whether Goldman Sachs fraudulently misrepresented that it intended to issue the IPO shares only to long term investors."
     Dissenting Judge Sheila Abdus-Salamm said she would reinstate the claims "to the extent that they are based on defendant's failure to disclose its compensation agreements with its customers."
     Even though the majority relied on Lenk's testimony before the SEC, the CEO had stated in the lawsuit that eToys would have priced its stock higher "based upon additional information." According to the judge, that testimony was improperly disregarded as "immaterial."
     "Although plaintiff has not raised any issue of fact regarding its contention that defendant misrepresented that it intended to issue the IPO shares to only long-term investors, there is evidence that plaintiff relied on defendant's advice about the pricing of the IPO without defendant having disclosed its compensation arrangements with its customers - such as its alleged strategy to use the 'trade up value' of underpriced IPOs to receive, as quid pro quos ... increased brokerage commissions and other business from recipients of IPO allocations. Accordingly, that portion of the fraud cause of action should be reinstated and resolved by the trier of fact," Abdus-Salamm stated.