Knock it off

Etsy Inc. is the latest of a slew of e-commerce sites being investigated for trading in counterfeit goods.

A month after Etsy Inc. went public and should have been rejoicing at its US$3.3-billion value, the “marketplace where people around the world connect, both online and offline, to make, sell and buy unique goods,” as it describes itself, was hit with a proposed class-action lawsuit.

Robbins Arroyo LLP, a San Diego law firm, announced in May that an Etsy investor had filed a federal securities fraud class-action complaint in the US District Court for the Eastern District of New York. The complaint alleged that the company and certain of its officers and directors violated the US Securities Exchange Act between April 16 and May 10.

The Brooklyn, NY-based e-commerce site that, among other services, sells handmade and vintage pieces and supplies, was accused of listing millions of items that likely violated trademarks. “A third-party report stated that over 5% [of the 40 million listings] offered for sale on Etsy may infringe on copyright or trademark rights and that the owners of those rights are more aggressively enforcing them,” classactionnews.com reported. “This case alleges that Etsy should have made more disclaimers about this potential problem during the IPO process.”

“Among the brands on the site that could be counterfeit include a wide range of Disney and NFL brands, plus Louis Vuitton, Chanel and Michael Kors,” Forbes reported.

The class-action complaint contended that Etsy made materially false and misleading statements regarding its business, operational and compliance policies. It noted, “Brands are increasingly pursuing sellers on Etsy for trademark or copyright infringement, jeopardizing the company’s listing fees and commissions.”

When word of the counterfeit concerns became public, Etsy’s stock took an immediate hit, dropping in value almost 20% by mid-May. Gil Luria, an analyst with Wedbush Securities, one of the largest securities firms and investment banks in the US, told CNBC how Etsy had veered away from its original mandate, which was to serve as the nexus of what has been called the “sharing economy,” a venue where artists could come together to sell their original crafts, often from their home.

“I think that Etsy a couple of years ago still had a pure, handmade and vintage goods marketplace,” Luria said. “But in order to accelerate growth into the IPO, [it] introduced manufactured goods, which brought with it mass manufactured goods. So, some seller buying 1,000 earrings for US0.05¢ on Alibaba [resold] them on Etsy for $20. They have also been fairly lax on preventing copyright and trademark infringement on the platform.”

Artisan Grace Dobush, in a February article in Wired magazine, articulated a similar observation. Entitled “How Etsy Alienated its Crafters and Lost its Soul,” she announced she had resigned from Etsy, where she had been selling her goods since 2006. A primary reason was Etsy’s decision to list “mass-manufactured items posing as handmade for a long time.” Many of these types of items were being sold at prices so low that crafters producing original products couldn’t compete.

As an example, she cited a listing for a “purportedly handmade lace dress going for US$65. [For those who aren’t up to date on their fabric prices, the materials to make a wedding dress alone would cost at least US$65.] A friend and I recently discovered we both always sort results by highest price when we’re searching on Etsy to see only the serious sellers. What other e-commerce sites can say the same?”

The obvious implication was that some of the listings offered counterfeit goods, a prospect that Dobush said the site didn’t seem receptive to hearing. “An Etsy staffer I met a few years ago dismissed sellers’ questions about Chinese resellers as ‘kind of racist,’ ” she wrote. “Any kind of ‘calling out’ of accused resellers or bad business people on Etsy’s forums is usually acknowledged by an admin shutting down the thread with ‘I’m going to close this up now.’ ”

The bad publicity in May was accompanied by Etsy’s disappointing first-quarter results. Although Etsy reported a top line of US$58.5 million, ahead of an expected US$58 million, it lost US$36.6 million in the quarter, or US84¢ a share. In comparison, in the year-ago quarter, the company had a US$463,000 loss.

Luria told CNBC that it was unlikely Etsy would be an acquisition target for eBay or Amazon, for example, as they had most of the buyers and sellers already. The company’s only hope, he suggested, was “to go back to basics,” to what made it special: the handmade, the vintage, the ethos that it had around social responsibility. “[It] really strayed away from that by allowing manufactured goods and by not cracking down on counterfeit. It’s frustrating [its] sellers and it’s [diluting its] brand to buyers.”

The Etsy situation might one day become a business school case history, where it could be used to illustrate the damage counterfeit goods can inflict on a brand. Typically, the focus has been on the large retailers that have to contend with knockoffs on a constant basis. But the Etsy case makes it clear that companies selling goods that turn out to be counterfeit could face serious consequences as well.

The size of the counterfeit market is staggering. Although accurate figures are hard to come by, due to the clandestine nature of the enterprise, the International Anti-Counterfeiting Coalition (IACC) estimates the value of global trade in counterfeit and pirated goods in 2015 at US$1.77 trillion.

The coalition, which is based in Washington, DC, bills itself as the world’s largest nonprofit organization devoted solely to protecting intellectual property and deterring counterfeiting.

In May, the IACC and the Canadian Anti-counterfeiting Network signed a memorandum of understanding that allows both organizations to collaborate on intellectual property enforcement initiatives and programs. “We believe that partnership and collaboration are key to fighting global challenges like counterfeiting and piracy,” IACC president Bob Barchiesi said.

While such an initiative is obviously a positive step, accountants and investigators who have worked on assignments involving counterfeited goods have discovered that it’s a vexing problem to contend with.

Apart from the sheer volume of fake items (aided and abetted by the ease with which they can be purchased over the Internet), investigators are increasingly encountering fakes that are hard to tell from the originals.

Geoff D’Eeon, who wrote and directed the CBC documentary Counterfeit Culture, said, “Even if you’re holding the real thing side-by-side with the fake, be it Ugg boots or Beats headphones by Dr. Dre, most of the time you can’t tell the difference.”

A few years ago, a Toronto man who sold counterfeit sports merchandise was visited by the RCMP, who told him they knew he was selling fake goods even though their top experts were unable to tell the fakes from the authentic merchandise. They advised him to stop, which he did.

Knowledge of the counterfeit market is important for accountants, especially those valuing a business. A large inventory of fake goods is obviously less valuable than a supply of real goods. The same applies if a flood, arson or another event has made inventory unsellable.

One way to assess the authenticity of goods, of course, is to engage an expert.

There are also indicators, however, that any accountant or investigator can look for. That process should begin with a visit to the website of the legitimate manufacturer. Many provide information about the gray market and tips for recognizing fake products.

Tell-tale signs could include an unrealistically low selling price, spelling or grammatical errors on the packaging, an absence of contact information for the manufacturer and the overuse of words such as real, genuine or authentic on the packaging. The latter suggests the seller is desperately trying to convince the buyer that the product is not a knockoff.

Another red flag is the absence of supplementary materials such as a user’s manual or a product registration card.

While red flags have been attached to Etsy in recent months for its alleged problems with counterfeit goods, it is by no means the only e-commerce company facing such scrutiny. Alibaba Group Holding Ltd., the Chinese online and mobile commerce company, has also come under fire.

A lawsuit in federal court in Manhattan, also filed in May, “by Gucci, Balenciaga, Yves Saint Laurent and other brands owned by Paris-based Kering SA, indicates that the company is unsatisfied with Alibaba’s efforts to address the problem of counterfeiting of its brands,” the Wall Street Journal reported.

The suit alleges that Alibaba and its associated companies “knowingly encourage, assist, and profit from the sale of counterfeits on their online platforms,” according to a copy of the filing reviewed by the newspaper.

Both eBay and Amazon have also faced counterfeit lawsuits.

Perhaps it is impossible for any e-commerce site to prevent counterfeiters from using their portal to sell knockoff goods, but there’s a difference between being exploited and turning a blind eye. Etsy and other sites perhaps have chosen the latter approach, and they may ultimately find it was the wrong one.

About the Author

David Malamed


David Malamed, CPA, CA•IFA, CPA (Ill.), CCF, CFE, CFI, is a partner in forensic accounting at Grant Thornton LLP in Toronto.

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