Whoever thought the plight of executives and investors at eToys–one of the signal flops of the high tech bubble era–would invite sympathy?
Joe Nocera’s fantastic Sunday column does just that, and it ought to result in yet another round of scandal coverage for Goldman Sachs. But there’s been little follow-up on this big story outside blog land.
Perhaps that’s because the story is 14 years old and two crises ago–a scoop of history. I say it’s news: A leopard doesn’t change its spots, and other business-news outlets should have followed Nocera’s scoop. If nothing else it raises questions about what else don’t we know about the dot.com bubble because it’s under seal in some courtroom or was never even dug up. We’ll presumably still be learning about the nastiness of the subprime bubble in 2020, and the press (and even some too-savvy bloggers) will still be rolling its eyes at its competitors’ reporting.
A little history: Shares in eToys, memorably, quadrupled on their first day of trading and went to zero less than two years later, having never gotten anywhere near profitability. It became a poster child of the manic dot.bomb era, along with gems like Pets.com and TheGlobe.com.
But the story isn’t so simple, it turns out, according to court documents Nocera found that were supposed to be sealed from public view. Here he is on the gist of eToys’s case against Goldman:
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.
It hit $78 on the open.
So Goldman Sachs intentionally set what its head underwriter thought was a super-low price for the IPO, gave access to the deal to favored clients, and then demanded the clients kick back much of their profits to Goldman in the form of fake trading commissions
Nocera says Goldman often asked for half of their clients’ first-day profits to be kicked back to it. One investor testified that 70 percent of his trading activity in the month of the eToys IPO was “pointless trades” whose only objective was to funnel money back to Goldman in return for access to its hot IPOs.
Felix Salmon, a contributing editor here, does the back-of-the-envelope math in a sharp piece on Nocera’s find:
eToys opened at $78 per share, which meant that Goldman’s clients were sitting on a profit of $475 million the minute that the stock started trading on the open market. In most cases, the clients cashed out — which was smart, because eToys didn’t stay at those levels for long. But if Goldman got back 40% of those profits in trading commissions, then it made $190 million in commissions, compared to that $11.5 million in fees.
And as Felix points out, the first page of Goldman’s pitch to get eToys’s IPO said, “eToys’ Interests Will Always Come First,” which if it’s not quite a fiduciary promise broken, as eToys claims in its suit, is awfully close to one.
Investors (the ones not on Goldman’s good list, that is) got hosed, and EToys lost out on hundreds of millions of dollars of capital it could have used to try to build a sustainable business. The only party that really made out here was Goldman Sachs.
See why Matt Taibbi called Goldman the Great American Bubble Machine?
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.