July 1, 2008 / 8:10 PM / 11 years ago

From handbags to diamonds, eBay a target, but safe

By Alexandria Sage - Analysis

John Donahoe, eBay President and Chief Executive Officer delivers the keynote address during the annual meeting of shareholders and auction sellers in Chicago, Illinois June 20, 2008. REUTERS/Frank Polich

SAN FRANCISCO (Reuters) - A French court dealt eBay Inc (EBAY.O) a blow for selling fake luxury goods, but while the Internet auctioneer’s business model is unlikely to change, further legal setbacks could shave its margins.

In the near term, the biggest damage could be to the eBay brand, which promises shoppers the widest range of goods in a marketplace that connects millions of buyers and sellers.

EBay has already upped its spending on people and technology to try to keep counterfeit items off its site, and further investments prompted by unfavorable court rulings would be mostly incremental at this point, analysts say.

“Does that destroy the business model or fundamentally change it?” asked Global Crown Capital analyst Martin Pyykkonen. “No, not really. It incrementally puts more pressure on margins ... to constantly police this and add headcount to their trust division.”

A French court ordered eBay on Monday to pay $61 million to LVMH (LVMH.PA), parent of the Louis Vuitton and Dior brands, for failing to properly monitor auctions.

In the United States, a federal judge is due to rule on whether it is the responsibility of eBay or plaintiff Tiffany & Co (TIF.N) to police the site for fake Tiffany diamonds.

Legal experts were not predicting the outcome of the eBay-Tiffany case, which will decide the ground rules of doing business in cyberspace and whether traditional notions of trademark and copyright protections deserve greater protection on the Web.

Although the lawsuits are a distraction for San Jose, California-based eBay, the bigger issue for investors is how the company revives stalled growth. Adjusted operating margins have stayed stable in the mid-30s due to cost controls, said Pyykkonen, but expansion will rely on sales growth.

“Unless they can accelerate the growth in their core business, all this other stuff is minor,” said Pacific Crest analyst Steve Weinstein. “(The Tiffany lawsuit) is not what’s going to drive the stock.”

Shares of eBay are down 18 percent since January as the company has made dozens of changes to improve how its core auction business works on behalf of buyers and sellers.

“Courts still go, ‘We don’t have a clear definitive ruling from high enough courts to know if there is potential for trademark liability,’” said J. Michael Huget, head of the intellectual property practice at the law firm Butzel Long.

Sally Abel, a lawyer who chairs Silicon Valley law firm Fenwick & West’s trademark group, said U.S. courts have been siding with a more open, “buyer-beware” marketplace. She cited recent cases where Google Inc (GOOG.O) has prevailed in lawsuits challenging its practice of letting rivals bid for trademarked search terms in its ads.

RESPONSIBILITY OF MIDDLEMEN?

Huget countered that eBay’s core defense — which it already provides sufficient trademark protections for brands willing to work with it to identify counterfeits — took a beating from the French court and could do so again in the United States.

“The more you start getting hit for this, I don’t care where it is, it makes it harder to justify this defense. I see that becoming more and more of a problem for them,” Huget said. “I would be sweating this one a little bit.”

EBay said it planned to appeal the French ruling. The company maintains that LVMH and a handful of other luxury brands are using the counterfeit goods issue as a “smokescreen” and that its real agenda is to keep a tight rein on distribution of goods outside its own sales channels.

In June, the European Union’s highest court said it would hear an appeal by Google in a counterfeit goods case brought by LVMH against Google that parallels the eBay case.

U.S. courts have largely taken the position that it is the trademark owner’s responsibility to establish which goods sold online are counterfeit. Under this view, Web services like eBay that act as middlemen are protected as long as they act quickly to remove fake items.

Nevertheless, “middlemen” like flea market operators or warehouse owners have been found liable for selling fake goods based on laws that favor strong trademark protection.

EBay claims that more than 90 percent of offending items are removed from its site within four hours after notification from rights holders and the issue is a red herring.

It counts 18,000 brand owners with which it works, including Apple Inc (AAPL.O), Coach Inc COH.N, Nike (NKE.N)and Oakley, through a simple process that allows them to notify eBay of fake goods on its site. By contrast, a handful of luxury brand groups such as LVMH have turned to litigation instead of working with eBay’s anti-fraud program.

Internet services argue they should be treated as neutral phone carriers and are not liable for communications over their lines, said Geoffrey Potter, head of the anti-counterfeiting practice at Kramer, Levin, Naftalis & Frankel.

“EBay would like to avoid that burden and is tempted to have itself viewed as something other than a store,” he said.

Additional reporting by Eric Auchard; editing by Patrick Fitzgibbons

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