The newest class action lawsuit against Yelp (NYSE:YELP) was filed last week at the U.S. District Court in San Francisco after company executives allegedly sold $81 million in an artificially inflated stock prior to news of unauthentic and fraudulent reviews becoming public. With 61 million cumulative reviews in Yelp's last quarter alone, some fraudulent reviews should be expected, but as the company continues to fight such allegations, how much faith should consumers put into the supposed experiences of others?
Questionable advertising antics
Yelp has become the go-to review site for consumers looking to share experiences and impressions with others. These reviews are highly valuable -- Yelp is worth $5 billion as a company -- influencing others on where to visit and creating many first impressions for users through social media.
The implications of fake reviews
Over a six-year span, Yelp has received well over 2,000 FTC complaints from small and large businesses claiming that their ratings were artificially altered after refusing to advertise on the company's platform, among other reasons. Yelp stated earlier this year that it receives on average six subpoenas per month, implying that the smoke created from such complaints is at least provoking local and perhaps federal investigations into its business practices.
Meanwhile, Yelp insists that it has never altered or removed reviews based on the advertising status of a business. But, as the debate and investigations race on, if the allegations are accurate, it can be a nightmare for small business owners.
The fire heats up
With that said, a class action suit against Yelp is nothing abnormal; these actually started rolling in from business owners on Yelp during 2010 with complaints over advertising and reviews. However, the story itself is starting to gain traction. Earlier this year, The Wall Street Journal reported that Yelp actually hurt the rating of small businesses who refused advertising, and soon after, the L.A. Times reported that Yelp had even negatively attacked the competing businesses of its larger advertisers, along with removing bad reviews for such advertisers.
In retrospect, Yelp has nearly 80,000 local business accounts, and in talking about these complaints it's a relatively small number in comparison to the total businesses on Yelp's platform. Still, with review sites like Yelp and Angie's List (NASDAQ: ANGI), there is perhaps a fundamental problem when the revenue is created from those businesses that are being reviewed. Certainly, Yelp wants to gain as much advertising revenue as possible, yet no one is going to advertise their two-star business for the world to see.
Instead, most businesses like to showcase their great reviews and ratings, which puts Yelp in a predicament when potential advertisers have low reviews. With that said, Angie's List has been criticized far more than Yelp because of its willingness to showcase businesses that advertise on their platform, who conveniently boast top rankings among reviewers.
Nonetheless of whether Yelp and other review sites are modifying, adding, or deleting reviews, legal proceedings are sure to follow, which will likely shed more light on the subject as a whole. But until then, basing an opinion on the review of what may or may not be legit, and choosing to give business to those with great Yelp ratings does not seem to be a reassuring practice. While the majority of Yelp's reviews are most likely legit, the simple fact is that consumers can not know with absolute certainty until the legal process runs its course. Thus, if Yelp's practices are widespread in this industry, finding the best restaurants, spas, shopping centers, and home services might be best done the old-fashioned way: trial and error.
Brian Nichols owns shares of Apple. The Motley Fool recommends Apple and Yelp. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.