If battling a copyright infringement suit with EA Games was not enough to keep Zynga on edge, the directors of the company are now in the spotlight for their own possible misdoings.  On July 30, 2012, the law firm of Newman Ferrara filed a class action complaint on behalf of Zynga’s stockholders accusing several Zynga directors, including CEO Mark Pincus and CFO David Wehner, of insider trading.

On December 16, 2011, Zynga conducted an IPO and issued 100 million shares of stock.  The market valued Zynga at approximately 10 billion dollars and Zynga common stock opened at $11 per share.  Though the stock price remained strong for the first few months, significant declines began in April of this year, when the stock was still at the $12 mark, dropping quickly to $6 in June and now languishing around $3 since August.

IPO agreements typically include a lock-up period, during which time certain shareholders are restricted from selling their stocks.  These agreements are usually for 90 to 180 days and aim to protect the integrity of the share price in the early period of an IPO.  Although it is common for directors to cash out some of their stock after the lock-up period, Zynga’s case raised suspicions because of the timing and circumstances of the directors’ actions; the directors cashed in their stock during the same quarter that Zynga began its steep, and widely unanticipated, decline, and the directors altered the original lock-up date to sell their shares almost two months in advance of the original restriction.

Zynga’s decision to adjust the lock-up date has proven to be of great financial consequence, as the directors, most of whom received around $12 a share in April, would have only been able to recoup approximately $6 a share if they had honored the original lock-up release date of May 28.  Considering the number of shares involved, the financial differences were significant.  For example, Marc Pincus sold approximately 16.5 million shares for proceeds of approximately $200 million, and David Wehner, the Chief Financial Officer, sold approximately 386,000 shares of for proceeds of approximately $4.6 million.  This translates to a difference of $100 million dollars for Pincus and $2.3 million dollars for Wehner, sums which would arguably tempt someone to test the boundaries of what is acceptable within the law.

Timing aside, the most troubling allegations in the complaint focus on insider trading – acting on material information not available to the public.  Since the directors sold their stock during the same quarter that Zynga announced a precipitous drop in present and future earnings, many find it difficult to believe that the directors did not possess inside information when making their decision.

While it is hard to avoid an uneasy feeling when looking at the sequence of these events, it is very possible that the officers’ conduct was not based upon insider information and was permissible under the law.  Though lock-up periods were once set in stone, underwriters have been showing increased flexibility in allowing the dates to be altered after the IPO.  In the past, such early release options were not always put in writing, however more modern approaches include incorporating stock statistics into agreements that allow directors to make a secondary offering as long as the stock is above a certain price for a prolonged period of time.  Though these practices are becoming more common, cases such as Zynga may make future directors more hesitant to exercise such rights, fearing the threat of litigation if, as in the case here, an alteration to a lock-up date precedes a significant, unexpected stock drop.  It will certainly be interesting if this case makes it to discovery to see what information then comes to light.