Tweet
Rigging the I.P.O. Game
By JOE NOCERA
ONCE upon a time, in a very different age, an Internet start-up called eToys went public. The date was May 20, 1999. The offering price had been set at $20, but investors in that frenzied era were so eager for eToys shares that the stock immediately shot up to $78. It ended its first day of trading at $77 a share.
The eToys initial public offering raised $164 million, a nice chunk of change for a two-year-old company. But it wasn’t even close to the $600 million-plus the company could have raised if the offering price had more realistically reflected the intense demand for eToys shares. The firm that underwrote the I.P.O. — and effectively set the $20 price — was Goldman Sachs.
After the Internet bubble burst — and eToys, starved for cash, went out of business — lawyers representing eToys’ creditors’ committee sued Goldman Sachs over that I.P.O. That lawsuit, believe it or not, is still going on. Indeed, it has taken on an importance that transcends the rise and fall of one small company during the first Internet craze.
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. (Through a Goldman Sachs spokesman, Fitt declined to comment. Goldman denies that it did anything wrong, about which more shortly.)
On some level, this argument — between those who believe companies are routinely sold down the river by their underwriters and those who insist that underwriting requires a complex balancing of the interests of both company and investors — has been going on ever since. Just a couple of years ago when the social media company LinkedIn went public and the stock quickly doubled, I wrote that the company had been scammed by its underwriters, Morgan Stanley and Bank of America’s Merrill Lynch unit. Money that rightly belonged to the company had instead gone to investment clients, I argued. A number of market observers responded by saying that I lacked a nuanced understanding of the complicated dynamics between companies, investors and underwriters.
Recently, however, I came across a cache of documents related to the eToys litigation that seem to tilt the argument in favor of the skeptics. Although the documents were supposed to be under seal, they were sitting in a file at the New York County Clerk’s Office, available to anyone who asked for them. I asked.
What they clearly show is that Goldman knew exactly what it was doing when it underpriced the eToys I.P.O. — and many others as well. (According to the lawsuit, Fitt led around a dozen underwritings in 1999, several of which were also woefully underpriced.) Taken in their entirety, the e-mails and internal reports show Goldman took advantage of naïve Internet start-ups to fatten its own bottom line.
Goldman carefully calculated the first-day gains reaped by its investment clients. After compiling the numbers in something it called a trade-up report, the Goldman sales force would call on clients, show them how much they had made from Goldman’s I.P.O.’s and demand that they reward Goldman with increased business. It was not unusual for Goldman sales representatives to ask that 30 to 50 percent of the first-day profits be returned to Goldman via commissions, according to depositions given in the case.
“What specifically do you recall” your Goldman broker wanting, asked one of the plaintiffs’ lawyers in a deposition with an investor named Andrew Hale Siegal.
“You made $50,000, how about $25,000 back?” came the answer. “You know, you made a killing.”
“Did he ever explain to you how to pay it back?” asked the lawyer.
“No. But we both knew that I knew how,” Siegal replied. “I mean, commissions, however I could generate.”
In one e-mail, a Goldman Sachs executive named David Dechman described hot I.P.O. deals as “a currency.” He asked, “How should we allocate between the various Firm businesses to maximize value to GS?”
Robert Steel, who was then co-head of equity sales at Goldman Sachs and is now one of New York Mayor Michael Bloomberg’s top deputies, sent an e-mail to one of the firm’s biggest clients, Putnam Investments in Boston, in which he wrote bluntly, “It is my view that we should be rewarded with additional secondary business for offering access to capital market product” — like hot I.P.O.’s.
Did the clients knuckle under?
Are you kidding?
According to data compiled by the plaintiffs, Capstar Holding, an investing client, made a series of pointless trades solely for Goldman’s benefit. The lawsuit quotes an investment manager at the firm, Christopher Rule, as saying that 70 percent of his trading activity in May 1999 was done to generate commissions for Goldman, “pursuant to an ‘understanding’ with his Goldman broker that he needed to generate money for Goldman in order to receive I.P.O.’s.”
On Thursday, Goldman Sachs issued a statement that read, in part, “We did not engage in quid pro quos for allocation of hot I.P.O.’s, and none of the decade-old documents distorted by the eToys litigants suggests otherwise.” I have posted a variety of the documents on The Times’s Web site, so that readers can decide for themselves what story they really tell.
Goldman supporters also point out that it was hardly the only underwriter to allocate shares of Internet public offerings based on what it would get in return. In the aftermath of the bubble, Goldman wound up paying fines to the Securities and Exchange Commission for I.P.O. excesses. But so did a lot of other firms. None of the government’s allegations, by the way, were related to the kind of practices alleged in the eToys lawsuit. As for the litigation itself, Goldman has argued that, contrary to popular belief, underwriters do not have a fiduciary duty to the companies they are underwriting. In recent years, this argument has held sway in the New York court system, although it has yet to be argued before the Court of Appeals.
GOLDMAN also pointed me to an e-mail Lawton Fitt wrote the day before the I.P.O., hoping to prevent firms that “are not long-term investors/aftermarket buyers” from getting too large an allocation. Even so, that e-mail made it clear that the “flippers” who didn’t care about eToys were still going to get around 20 percent of the allocation. The e-mail isn’t quite the ringing defense that Goldman makes it out to be.
What is undeniably true, of course, is that the documents are old. Some will dismiss them as relics of another era. But I continue to believe that the mind-set created by the I.P.O. madness of the late 1990s never really went away. To this day, an I.P.O. with a big first-day jump is considered a success, even though the company is being short-shrifted. To this day, investors know that they are expected to find ways to reward the firms that allocate them hot I.P.O. shares. The only thing that is truly different today is that few on Wall Street are so foolish as to put such sentiments in an e-mail.
Earlier this week, I tracked down Toby Lenk, the founder and former chief executive of eToys. Back when the S.E.C. was investigating I.P.O. excesses, the government deposed him. During the deposition, he mostly defended Goldman Sachs, even though he had the uneasy feeling that eToys had been taken advantage of.
After the deposition, he recalled, the S.E.C. lawyers began to show him some Goldman Sachs documents. He saw that one big firm after another had been allocated shares — and had immediately flipped them, even though Goldman had promised that its clients would support the stock. “That’s when I thought, ‘We really got screwed,’” Lenk told me.
Although the experience still angered him, he now has 14 years’ worth of perspective. “Look at what has happened since then,” he said. “If you think eToys got screwed, what do you think happened to the country?”
“What Wall Street did to us in 1999 pales in comparison to what they did to the country in 2008,” he said.
http://www.nytimes.com/2013/03/10/opinion/sunday/nocera-rigging-the-ipo-game.html?ref=opinion&_r=0
By JOE NOCERA
ONCE upon a time, in a very different age, an Internet start-up called eToys went public. The date was May 20, 1999. The offering price had been set at $20, but investors in that frenzied era were so eager for eToys shares that the stock immediately shot up to $78. It ended its first day of trading at $77 a share.
The eToys initial public offering raised $164 million, a nice chunk of change for a two-year-old company. But it wasn’t even close to the $600 million-plus the company could have raised if the offering price had more realistically reflected the intense demand for eToys shares. The firm that underwrote the I.P.O. — and effectively set the $20 price — was Goldman Sachs.
After the Internet bubble burst — and eToys, starved for cash, went out of business — lawyers representing eToys’ creditors’ committee sued Goldman Sachs over that I.P.O. That lawsuit, believe it or not, is still going on. Indeed, it has taken on an importance that transcends the rise and fall of one small company during the first Internet craze.
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. (Through a Goldman Sachs spokesman, Fitt declined to comment. Goldman denies that it did anything wrong, about which more shortly.)
On some level, this argument — between those who believe companies are routinely sold down the river by their underwriters and those who insist that underwriting requires a complex balancing of the interests of both company and investors — has been going on ever since. Just a couple of years ago when the social media company LinkedIn went public and the stock quickly doubled, I wrote that the company had been scammed by its underwriters, Morgan Stanley and Bank of America’s Merrill Lynch unit. Money that rightly belonged to the company had instead gone to investment clients, I argued. A number of market observers responded by saying that I lacked a nuanced understanding of the complicated dynamics between companies, investors and underwriters.
Recently, however, I came across a cache of documents related to the eToys litigation that seem to tilt the argument in favor of the skeptics. Although the documents were supposed to be under seal, they were sitting in a file at the New York County Clerk’s Office, available to anyone who asked for them. I asked.
What they clearly show is that Goldman knew exactly what it was doing when it underpriced the eToys I.P.O. — and many others as well. (According to the lawsuit, Fitt led around a dozen underwritings in 1999, several of which were also woefully underpriced.) Taken in their entirety, the e-mails and internal reports show Goldman took advantage of naïve Internet start-ups to fatten its own bottom line.
Goldman carefully calculated the first-day gains reaped by its investment clients. After compiling the numbers in something it called a trade-up report, the Goldman sales force would call on clients, show them how much they had made from Goldman’s I.P.O.’s and demand that they reward Goldman with increased business. It was not unusual for Goldman sales representatives to ask that 30 to 50 percent of the first-day profits be returned to Goldman via commissions, according to depositions given in the case.
“What specifically do you recall” your Goldman broker wanting, asked one of the plaintiffs’ lawyers in a deposition with an investor named Andrew Hale Siegal.
“You made $50,000, how about $25,000 back?” came the answer. “You know, you made a killing.”
“Did he ever explain to you how to pay it back?” asked the lawyer.
“No. But we both knew that I knew how,” Siegal replied. “I mean, commissions, however I could generate.”
In one e-mail, a Goldman Sachs executive named David Dechman described hot I.P.O. deals as “a currency.” He asked, “How should we allocate between the various Firm businesses to maximize value to GS?”
Robert Steel, who was then co-head of equity sales at Goldman Sachs and is now one of New York Mayor Michael Bloomberg’s top deputies, sent an e-mail to one of the firm’s biggest clients, Putnam Investments in Boston, in which he wrote bluntly, “It is my view that we should be rewarded with additional secondary business for offering access to capital market product” — like hot I.P.O.’s.
Did the clients knuckle under?
Are you kidding?
According to data compiled by the plaintiffs, Capstar Holding, an investing client, made a series of pointless trades solely for Goldman’s benefit. The lawsuit quotes an investment manager at the firm, Christopher Rule, as saying that 70 percent of his trading activity in May 1999 was done to generate commissions for Goldman, “pursuant to an ‘understanding’ with his Goldman broker that he needed to generate money for Goldman in order to receive I.P.O.’s.”
On Thursday, Goldman Sachs issued a statement that read, in part, “We did not engage in quid pro quos for allocation of hot I.P.O.’s, and none of the decade-old documents distorted by the eToys litigants suggests otherwise.” I have posted a variety of the documents on The Times’s Web site, so that readers can decide for themselves what story they really tell.
Goldman supporters also point out that it was hardly the only underwriter to allocate shares of Internet public offerings based on what it would get in return. In the aftermath of the bubble, Goldman wound up paying fines to the Securities and Exchange Commission for I.P.O. excesses. But so did a lot of other firms. None of the government’s allegations, by the way, were related to the kind of practices alleged in the eToys lawsuit. As for the litigation itself, Goldman has argued that, contrary to popular belief, underwriters do not have a fiduciary duty to the companies they are underwriting. In recent years, this argument has held sway in the New York court system, although it has yet to be argued before the Court of Appeals.
GOLDMAN also pointed me to an e-mail Lawton Fitt wrote the day before the I.P.O., hoping to prevent firms that “are not long-term investors/aftermarket buyers” from getting too large an allocation. Even so, that e-mail made it clear that the “flippers” who didn’t care about eToys were still going to get around 20 percent of the allocation. The e-mail isn’t quite the ringing defense that Goldman makes it out to be.
What is undeniably true, of course, is that the documents are old. Some will dismiss them as relics of another era. But I continue to believe that the mind-set created by the I.P.O. madness of the late 1990s never really went away. To this day, an I.P.O. with a big first-day jump is considered a success, even though the company is being short-shrifted. To this day, investors know that they are expected to find ways to reward the firms that allocate them hot I.P.O. shares. The only thing that is truly different today is that few on Wall Street are so foolish as to put such sentiments in an e-mail.
Earlier this week, I tracked down Toby Lenk, the founder and former chief executive of eToys. Back when the S.E.C. was investigating I.P.O. excesses, the government deposed him. During the deposition, he mostly defended Goldman Sachs, even though he had the uneasy feeling that eToys had been taken advantage of.
After the deposition, he recalled, the S.E.C. lawyers began to show him some Goldman Sachs documents. He saw that one big firm after another had been allocated shares — and had immediately flipped them, even though Goldman had promised that its clients would support the stock. “That’s when I thought, ‘We really got screwed,’” Lenk told me.
Although the experience still angered him, he now has 14 years’ worth of perspective. “Look at what has happened since then,” he said. “If you think eToys got screwed, what do you think happened to the country?”
“What Wall Street did to us in 1999 pales in comparison to what they did to the country in 2008,” he said.
http://www.nytimes.com/2013/03/10/opinion/sunday/nocera-rigging-the-ipo-game.html?ref=opinion&_r=0
Comment