Zynga hit with class action suit over insider dealing claims

Lawyers are looking at Zynga for alleged insider trading and whether key Zynga insiders sold shares just before the price plummeted.

Rumours have been going around that Facebook might move in to purchase Zynga now that Zynga's stock value has dropped in value by 75 per cent. However, news of a class action suit over alleged insider dealing might stop Facebook from proceeding right now.

It could make sense for Facebook to buy Zynga and modify its UI to be more Zynga friendly -- the number of users playing the games has declined, fuelling speculation that Facebook had stopped promoting Zynga games in order to lower the price before it bought Zynga.

Fluctuations in user numbers for Zynga games happen all the time. Draw Something plummeted in popularity after Zynga acquired it, after reaching 50 million downloads in less than two months.

However, in Zynga's earnings report it said that Facebook changed its algorithm to showcase newer Zynga games such as The Ville to encourage new user sign up.

It doesn’t make sense for Facebook to buy Zynga just because its price is low. Facebook does not necessarily sweep up every struggling company that it finds. Nor does it make sense for Facebook to see Zynga struggle.

With Facebook depending on Zynga for 12 per cent of its revenue, the risks to its growth would be just too high. Facebook listed Zynga as one of the key factors in its success according to its IPO filing.

Facebook depends on Zynga and it devoted an entire addendum to the filing over its continued good relationship

A class action lawsuit was filed this week naming Zynga for 'violation against federal securities laws for insider dealings during the period February 28th 2012 to July 25th 2012'.

Eileen Brown ZDNet Mark Pincus
Zynga CEO Mark Pincus (Credit: Rafe Needleman/CNET)

 It is alleged that when common stock was being offered for sale, directors of Zynga such as Mark Pincus, CEO, David M. Wehner, CFO, John Schappert, COO, Mark Vranesh, CAO, Reginald D. Davis, SVP and Cadir B. Lee, CTO were selling stock during the offer period.

The class action suit claims that the common stock of Zynga was at ‘artificially inflated prices’ and the stock declined in value when:

“... the misrepresentations made to the market, and/or the information alleged herein to have been concealed from the market, and/or the effects thereof, were revealed, causing investors’ losses.”

Zynga completed its IPO in December 2011. At the time the company was valued at $10 billion with stock opening at an initial price of $11 per share. Zynga’s shares slumped 10 per cent below IPO on the first day of trading.

Growth expectations

In the IPO prospectus, Zynga stated that it expected to grow:

'We are making significant investments in 2011 to drive long-term growth. We continue to invest in game development, creating both new games and new features and content in existing games designed to engage our players.

We are also investing in other key areas of our business, including international market development, mobile games and our technology infrastructure.

During the fourth quarter of 2011, we expect to make capital expenditures of approximately $50 million to $70 million as we invest in network infrastructure to support our expected growth and to continue to improve the player experience'.

In fact growth was also expected for 2012. When Zynga announced its outlook for 2012 it stated that:

“Bookings are projected to be in the range of $1.35 billion to $1.45 billion. We expect that growth will be weighted towards the back-half of the year with slower sequential growth in the first half of the year.”

The stock price rose during the class offering to high during the preiod of $15.91 per share on March 2nd 2012. 10 days later on March 14th Zynga filed a secondary offering of 49,414,526 shares for ‘certain insider shareholders’.

Waiving restrictions

The IPO filing initially stated that shares were not to be sold until the lock up period had ended on May 28th 2012.

However, on March 23rd 2012 – 9 days later, Zynga filed an amendment to the form S-1 which waived the lock up restrictions for the previously restricted Zynga insiders.

This meant that the Zynga insiders could sell their shares of Zynga stock on April 3rd -- well before the lock in period ended on May 28th. The Zynga insiders sold over 43 million personally held shares at $12.00 per share, for proceeds of approximately $516 million.

Price plunge

Zynga’s second quarter results were poor. It reported a net loss of $22.8 million in the second quarter of 2012. The same quarter of 2011 showed a net income gain of $1.4 million. After the announcement of the earnings, Zynga stock dropped to $2.97 per share.

The insiders appeared to have cashed out at “exactly the right time”.

It also ‘drastically’ lowered its full year outlook for the rest of 2012 which, according to the suit:

“... directly contradicted management’s prior comments about expected bookings growth that Zynga’s bookings would be weighted more heavily towards the second half of 2012.”

Since the completion of the secondary offering on April 3rd, Zynga’s stock value has dropped by 75 per cent. The Insiders sold their shares before the stock price plummet according to the filing.

Poor business performance meant that John Schappert was demoted yesterday. His role as head of game development focused on reviving growth and earning money from mobile.

Did Zynga fail to report or disclose certain types of information, dependency on Facebook and declining users for stock price decline -- or was poor management, lack of market experience and IPO overhype to blame? 

Let the lawyers decide...