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From Securities Regulation Daily, March 27, 2015

Game on in shareholder fraud action against Zynga

By Amy Leisinger, J.D.

The Northern District of California has denied a motion to dismiss fraud claims against online gaming company Zynga, Inc. and certain individual defendants. While the court found that Zynga’s representation that the company’s new game pipeline was “robust” qualified as puffery, its assurances of strength while numbers were declining and its failure to disclose potential known changes to Facebook that would harm its business constituted actionable misstatements and omissions. The court also found that the plaintiff adequately alleged facts to support a strong inference of scienter, and, as such, the Exchange Act Section 20(a) controlling person claims were also allowed to proceed (In re Zynga Inc. Securities Litigation, March 25, 2015, White, J.).

Background. The plaintiff filed a complaint alleging that the defendants engaged in a deliberate scheme to mislead investors by portraying Zynga as financially strong in order to bring the company public and allowing insiders to reap profits by selling their shares before the company’s stock price fell. Specifically, the complaint stated that the defendants concealed information demonstrating that Zynga’s bookings were declining, that there were significant product release delays, and that a planned platform change at Facebook would negatively affect the company’s business.

As a result of the court’s determination (covered in the Securities Regulation Daily Wrap Up for February 26, 2014) that the plaintiff did not have standing to bring claims regarding misstatements or omissions in Zynga’s registration statement without evidence of shares purchases in the offering, the plaintiff filed an amended consolidated complaint that abandoned Securities Act claims. However, the plaintiff continued to allege that the defendants fraudulently concealed information.

Actionable misstatements and omissions. The court noted that the PSLRA requires particularized allegations concerning the reasons why a certain statement or omission was false or misleading as to a material fact. The defendants contended that their representations about the strength of their bookings were not false and misleading because their reported financial results were the highest in the company’s history, the court stated, but the plaintiff has provided evidence that bookings were in fact declining during the class period. In addition, the court found that the plaintiff plausibly alleged that the defendants knew of the impending Facebook changes that would affect Zynga’s business by means of summaries provided to executives, which rendered the company’s representations sufficiently misleading.

Further, the court reasoned, if premised upon these allegations, the alleged misrepresentations in Zynga’s projections and growth expectations could constitute actionable forward-looking statements. “At the least, Plaintiff has adequately alleged that Defendants were ‘aware of undisclosed facts tending seriously to undermine’ the accuracy of their financial guidance,” the court stated.

However, the plaintiff’s allegation that the defendants misleadingly represented that Zynga’s game pipeline was “strong,” “robust,” and “very healthy” must fail as non-actionable corporate puffery, the court concluded. The delays in game launches did not necessarily mean a lack of strength, and the defendants’ “general enthusiasm” was an overall assessment, the court explained.

Scienter. The court also found that the plaintiff adequately alleged facts giving rise to a strong inference of scienter. Confidential witnesses have testified at length as to the information available to Zynga’s management, including bookings numbers, game-operating metrics, and the pending changes to the Facebook platform, the court reasoned, and these particularized facts support a finding as to the defendants’ states of mind. 

Loss causation. The defendants contended that the plaintiff failed to plead loss causation, a causal connection between the alleged deceptive acts and the injury suffered, because there was no allegation that the market was reacting to revelations instead of general negative financial reports.  However, the court noted, “the requirements for pleading loss causation are ‘not meant to impose a great burden upon a plaintiff,” and allegations of paying an artificially inflated price for stock that fell in value after true facts came to light are sufficient to show a triable issue of loss causation.

Because the court found allegations sufficient to maintain a cause of action for a primary violation, the plaintiffs’ Section 20(a) controlling person claim was also allowed to proceed.

The case is No. C 12-04007 JSW.

Attorneys: Nicole Catherine Lavallee (Berman DeValerio) and Roy Shimon (Newman Ferara LLP) for Mark H. Destefano. Jordan Eth (Morrison & Foerster LLP) for Zynga, Inc. Bruce D. Angiolillo (Simpson Thatcher & Bartlett LLP) for Morgan Stanley & Co. LLC, Goldman, Sachs & Co., J.P. Morgan Securities LLC and Merrill Lynch.

Companies: Zynga, Inc.; Morgan Stanley & Co. LLC; Goldman, Sachs & Co.; J.P. Morgan Securities LLC; Merrill Lynch

MainStory: TopStory CaliforniaNews FraudManipulation

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