In June, the disruptive, addictive, social gaming juggernaut Zynga vowed to transform the way games are built and consumed. By July 31, after a precipitous stock tumble, Zynga CEO Mark Pincus and other leaders are facing a class-action lawsuit for insider trading from angry investors who saw their fortunes evaporate while executives cashed out their winnings in high-rolling style. If this all sounds familiar, it's because you heard a similar story a few months ago from Zynga's big brother, Facebook.
Here are highlights of the court filing:
- Before Zynga went public, its officers and directors agreed to not sell their stocks for 165 days, an agreement that would expire May 28, 2012. Waiving this lock-up would required the approval of Morgan Stanley and Goldman Sachs, which backed the IPO.
- Feb. 28, Zynga issued a press release reporting record 2011 sales and predicting favorable earnings in 2012. Perhaps most important was its assertion that "growth will be weighted towards the back-half of the year" -- in other words, buy now, things are going to get even better. Shares hit an all-time high March 2.
- At this point, Zynga asked the Securities and Exchange Commission if it could sell more of its stock to investors. At the same time, Zynga also asked to waive the lock-up restriction so executives could sell nearly 50 million shares.
- The underwriting banks received $15 million in fees for the second stock offering, the officers received more than $500 million, while Zynga's everyday employees were unable to sell any of their holdings.
- Zynga's executives sold their stock April 3 -- in advance of Q2 financial results -- for $12 a share.
- April 26, Zynga released more rosy estimates based on growing first-quarter growth, and executives continued to assert that 2012 growth would be "weighted towards the back-half of the year."
But then the rose faded, fast.
- July 25, Zynga released lower-than-expected second-quarter results, including a profit 84% lower than expected. Zynga also lowered its 2012 targets significantly below the April estimates. It lowered sales by roughly 20%, earnings by roughly 82%, and EBITDA (another way of counting earnings) by roughly 50%. Analysts, in turn, slashed their ratings of Zynga's stock, which plummeted.
- The lawsuit alleges that the defendants acted with scienter, which means that a party understands that it is about to commit wrongdoing before doing so. It also alleges that Zynga executives intentionally misled the public and the markets about their company's prospects in order to "cause Plaintiff and other members of the Class to purchase Zynga's securities at artificially inflated prices" and line their own pockets. The class includes everyone who purchased stock between Feb. 28 and July 25, 2012.
The courts will have their hands full with this one, but one thing is impossible to deny–Zynga's leaders (and their bankers) certainly did well. Pincus earned $200 million on the deal (which more than paid for the $16 million mansion he bought while Zynga burns), and four other investors (including Google) made $48 million or more.
How the trades occurred was unorthodox and their timing was impeccable, but was it malicious and illegal? Insider trading is notoriously difficult to prove, but guilty or not, Zynga looks bad. Shareholder confidence is at an all-time low, and employee morale can't be much higher. The case will almost certainly go to trial because a settlement would taint the company for years, and that means there will be no rapid or graceful end to the matter.
Zynga has managed to catch one unexpected break. Its real-cash gaming aspirations never materialized. Had Pincus steered Zynga into online gambling, it might also be part of a fraud probe of Internet poker firms currently being conducted by the Department of Justice. One lawsuit at a time.
Mark Pincus photo by Jason Lloren.