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From Securities Regulation Daily, November 17, 2014

Easing lockups for Zynga directors may have breached fiduciary duties

By Anne Sherry, J.D.

A class action plaintiff challenging a restructuring of Zynga, Inc.’s lockup provisions shortly after its IPO cleared an early hurdle by defeating the director defendants’ motion to dismiss. The court held that the complaint stated a claim for breach of fiduciary duty because it was reasonably conceivable that half of the directors who approved the restructuring received an unfair benefit (Lee v. Pincus, November 14, 2014, Bouchard, A.).

Background. A few months after Zynga’s December 2011 IPO, the board approved a waiver of lockup provisions as they applied to four of the eight directors. The waiver meant that those directors were able to sell a portion of their holdings through a secondary offering in early April 2012, almost two months before other pre-IPO stockholders. The secondary offering was priced at $12 per share; the plaintiff’s shares remained locked up until the end of May, when the closing price was just over $6 per share. Two directors alone received over $192 million in proceeds from their sales of stock in the secondary offering, and the two investment banks that consented to the lockup waivers made over $10 million in fees for underwriting the offering.

Direct claim. First, the court determined that the plaintiff could bring the claim directly rather than derivatively on behalf of the corporation. The plaintiff alleged no harm to the corporation or to all stockholders, but instead individualized harm affecting only the putative class of pre-IPO stockholders. Furthermore, the claim did not sound in contract, but was properly styled as a breach of fiduciary claim, even though the class members’ shares were governed by contracts containing lockup restrictions. The contracts did not eliminate the directors’ fiduciary duties to act loyally to all Zynga stockholders, especially when the challenged action did not involve the exercise of any contractual right governing the plaintiff’s shares but instead modifications to the contractual provisions governing the directors’ shares.

Viable fiduciary duty claim. At the motion-to-dismiss stage, the court determined, affording the plaintiff all reasonable inferences, it was reasonably conceivable that the opportunity to sell earlier afforded the directors a benefit that outweighed any detriment from the lockup extensions, in violation of their fiduciary duties. Before the lockup restructuring, the director defendants and the putative class of Zynga stockholders were similarly situated, with all lockups to expire on the same date. Through the restructuring, four of the director defendants received lockup waivers allowing them to sell earlier than the putative class could. These circumstances were distinguishable from the case on which the director defendants relied, where the court was able to conclude definitively at the pleadings stage that the challenged transaction did not confer a benefit upon the directors.

Aiding and abetting. The court did dismiss the plaintiff’s claim that the underwriter defendants aided and abetted the breach of fiduciary duty. Allegations that the underwriters profited from the lockup restructuring did not support a reasonable inference of knowing participation by the underwriter defendants, in the absence of any facts implying that the underwriters knew that their consent to the modification would facilitate a breach of fiduciary duty. Furthermore, the complaint did not allege that the fees the underwriters received in connection with the secondary offering were unreasonable.

The case is No. 8458-CB.

Attorneys: Elizabeth M. McGeever (Prickett, Jones & Elliott, P.A.) and Ethan D. Wohl (Wohl & Fruchter LLP) for Wendy Lee. Gregory V. Varallo (Richards, Layton & Finger, P.A.) and Bruce D. Angiolillo (Simpson Thatcher & Bartlett LLP) for Mark Pincus, John Schappert, William Gordon, Reid Hoffman, Jeffrey Katzenberg, Stanley J. Meresman, Sunil Paul, Owen Van Natta and Zynga, Inc. Simona G. Strauss (Simpson Thatcher & Bartlett LLP) for Morgan Stanley & Co. LLC and Goldman, Sachs & Co.

Companies: Zynga, Inc.; Morgan Stanley & Co. LLC; Goldman, Sachs & Co.

MainStory: TopStory DirectorsOfficers CorporateGovernance DelawareNews

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