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New York’s Court of Appeals Tuesday imposed a fiduciary responsibility on the lead underwriter of an initial public offering, holding for the first time that when such entities serve as expert advisors they are obligated to reveal any conflicts of interest. Tuesday’s benchmark ruling in EBC I Inc. v. Goldman, Sachs & Co., 61, was intentionally narrow. Yet the sole dissenter said the holding will have a dramatic impact on some Wall Street relationships, upsetting both law and tradition in imposing a new burden on underwriters. The case arose out of the Internet boom of the late 1990s, when Goldman, Sachs & Co. took on the role of lead underwriter for an initial public offering of eToys Inc. common stock. eToys, now EBC I Inc., marketed children’s products on the Internet. Allegedly on Goldman Sachs’ recommendation, the IPO was priced at $20 per share. However, over the first several months the stock traded at prices as high as $86 per share. Later, the stock took a nosedive, as did eToys’ operating capital, and the firm ended up in Chapter 11 bankruptcy. In connection with the bankruptcy action, the Official Committee of Unsecured Creditors appointed in the Chapter 11 sued Goldman Sachs, claiming the firm intentionally underpriced the shares. The plaintiffs claimed that Goldman Sachs was selling its own eToys stock at a far higher price than the IPO and taking kickbacks from favored clients to whom it had allocated shares. Tuesday, the Court of Appeals dismissed claims for breach of contract, professional malpractice and unjust enrichment. But it agreed with the Appellate Division, 1st Department, and the trial court that the claim for breach of fiduciary duty should proceed. Writing for the six-judge majority, Judge Carmen Beauchamp Ciparick disputed Goldman Sachs’ argument that the finding of a fiduciary duty would significantly impair the underwriting industry, stressing that such a duty exists only to the extent that the underwriter acts as an advisor. “We do not suggest that underwriters are fiduciaries when they are engaged in activities other than rendering expert advice,” she wrote. “When they do render such advice, the requirement to disclose to the issuers any material conflicts of interest that render the advice suspect should not burden them unduly.” But Judge Susan Phillips Read, in dissent, said she is “less sanguine than the majority about the consequences.” She said eToys was “a sophisticated, well-counseled business entity” represented by a specialty law firm — Venture Law Group, a California technology practice that has since merged with Heller Ehrman White & McAuliffe — and urged the Court to refrain, as it has in the past, from “injecting fiduciary obligations into sophisticated, counseled parties’ arm’s-length commercial dealings.” “This new fiduciary obligation wars against our precedent and potentially conflicts with a highly complex regulatory framework designed to safeguard investors,” Read said, adding that the court was, at the least, introducing great uncertainty into the dealings. “This subject is, in my view, better dealt with by specialized regulators than by evolving common law.” FUTURE IMPACT Stanley M. Grossman of Pomerantz Haudek Block Grossman & Gross in Manhattan, counsel for EBC I, said he does not foresee the sea change feared by Goldman Sachs and Read. He said the ruling is confined to those instances where an underwriter plays a fiduciary role. “Typically, it is the underwriters who really set the price in IPOs,” Grossman said. “To the extent that the issuer relies on that advice, a fiduciary relationship is formed. If they don’t want to be a fiduciary, fine, tell [the client] that [the underwriter] is working at arm’s-length and, if they want someone to represent their interests, they need to get another banker. That’s all they need to say.” John L. Warden of Sullivan & Cromwell in Manhattan, who argued for Goldman Sachs, was not immediately available for comment.

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