WENDY LEE, individually and on behalf of all others similarly situated, Plaintiff,
MARK PINCUS, JOHN SCHAPPERT, WILLIAM GORDON, REID HOFFMAN, JEFFREY KATZENBERG, STANLEY J. MERESMAN, SUNIL PAUL, OWEN VAN NATTA, MORGAN STANLEY & CO. LLC, GOLDMAN, SACHS & CO., AND ZYNGA INC., Defendants.
Submitted: August 22, 2014
Elizabeth M. McGeever and J. Clayton Athey of PRICKETT, JONES & ELLIOT, P.A., Wilmington, Delaware; Ethan D. Wohl of WOHL & FRUCHTER LLP, New York, New York, Attorneys for Plaintiff.
Danielle Gibbs and Nicholas J. Rohrer of YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Jordan Eth, Anna Erickson White and Kevin A. Calia of MORRISON & FOERSTER LLP, San Francisco, California, Attorneys for Defendants Mark Pincus, John Schappert, William Gordon, Reid Hoffman, Jeffrey Katzenberg, Stanley J. Meresman, Sunil Paul, Owen Van Natta, and Zynga Inc.
Gregory V. Varallo, Thomas A. Uebler and Robert L. Burns of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Bruce D. Angiolillo and Jonathan K. Youngwood of SIMPSON THACHER & BARTLETT LLP, New York, New York; Simona G. Strauss of SIMPSON THACHER & BARTLETT LLP, Palo Alto, California, Attorneys for Defendants Morgan Stanley & Co. LLC and Goldman, Sachs & Co.
This action involves allegations by a stockholder of Zynga Inc. ("Zynga") that, a few months after the company completed its initial public offering in December 2011, the board of directors waived in a discriminatory manner certain contractual restrictions that had prevented most pre-IPO investors from selling their stock for a designated period. Selectively waiving these "lockup" restrictions permitted some pre-IPO stockholders to sell a portion of their holdings almost two months before other pre-IPO stockholders, at what turned out to be a significantly higher price than was available later. Four of Zynga's eight directors received this opportunity. Plaintiff claims that Zynga's directors breached their fiduciary duty of loyalty by approving a self-dealing waiver of these lockups to the unfair benefit of half the members of the Zynga board (Count I). Plaintiff also claims that two investment banks, whose consent was necessary to waive the lockups, aided and abetted these breaches of fiduciary duty (Count II).
As discussed below, the specific waivers at issue were part of a larger decision by the Zynga board to restructure the lockup restrictions covering approximately 688 million shares of Zynga stock. This figure equates to almost seven times the number of shares (100 million shares) issued in the company's IPO. All of the lockups were set to expire on the same day: May 28, 2012. But, in March 2012, the Zynga board decided to stagger the lockup expirations, which would have the effect of gradually making more stock available to the public.
With their lockups modified, a group of pre-IPO stockholders were thereby able to participate in a secondary offering to the public that closed in early April 2012 at a price of $12.00 per share. Each of the four Zynga directors who received lockup waivers sold millions of dollars of Zynga stock in this secondary offering. Zynga's founder, Chairman, and then-Chief Executive Officer, Mark Pincus, alone received over $192 million in proceeds. The two investment banks that consented to the lockup waivers together made over $10 million in fees by acting as underwriters for the secondary offering. Plaintiff's shares, in contrast to those of the four directors who participated in the secondary offering, remained locked up until May 29, 2012, when the closing price for Zynga's stock was $6.09 per share.
Zynga and the eight director defendants moved to dismiss Count I under (i) Court of Chancery Rule 23.1 for failure to make a pre-suit demand upon Zynga's board or to plead facts excusing such demand and (ii) Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief may be granted. The two underwriter defendants moved to dismiss Count II under Court of Chancery Rule 12(b)(6) for failure to state a claim.
In this opinion, I conclude that plaintiff has stated a claim for breach of fiduciary duty against the director defendants because it is reasonably conceivable that, when the members of the Zynga board restructured the lockup restrictions, half of the directors who approved that decision received an unfair benefit. I also conclude that plaintiff has not stated a claim for aiding and abetting because plaintiff has failed to plead facts from which it is reasonably inferable that the underwriters knowingly participated in a breach of fiduciary duty. Accordingly, the motion to dismiss Count I is denied, and the motion to dismiss Count II is granted.
A. The Parties
Defendant Zynga, a Delaware corporation based in San Francisco, California, is in the "social gaming" industry. Zynga produces interactive, online games (think FarmVille) that are accessible through facebook.com and other platforms. It generates income primarily through advertising and selling so-called "virtual goods." Its stock trades on the NASDAQ. Zynga is named as a defendant "solely because it is a party to agreements underlying and relating to the [s]econdary [o]ffering."
Between the company's IPO in December 2011 and the secondary offering in April 2012, Zynga's board consisted of eight individuals: defendants Mark Pincus ("Pincus"), John Schappert ("Schappert"), William Gordon, Reid Hoffman ("Hoffman"), Jeffrey Katzenberg, Stanley J. Meresman, Sunil Paul, and Owen Van Natta ("Van Natta"). All eight individuals had been directors of Zynga since November 2011. Four of these directors received lockup waivers and then sold stock in the secondary offering: Pincus, Schappert, Hoffman, and Van Natta. I refer to the eight individual defendants as the "Director Defendants, " and to the Director Defendants and Zynga, collectively, as the "Zynga Defendants."
Defendant Pincus founded Zynga in 2007. Through his ownership of high-voting stock, Pincus controlled 37.4% of Zynga's voting power immediately after the company's IPO, and 36.5% immediately before the secondary offering. He sold 16.5 million shares in the secondary offering and received $192, 060, 000 in net proceeds, equating to $11.64 per share. Defendants Schappert, Hoffman, and Van Natta together sold approximately 1.5 million shares in the secondary offering, receiving over $17.6 million in net proceeds.
Defendant Morgan Stanley & Co. LLC ("Morgan Stanley") is a Delaware limited liability company based in New York. Defendant Goldman, Sachs & Co. ("Goldman") is a New York limited partnership also based in New York. Morgan Stanley and Goldman (together, the "Underwriter Defendants") served as the lead underwriters, and as the representatives for the other underwriters, in Zynga's IPO and the secondary offering.
Plaintiff Wendy Lee ("Lee") has been a Zynga stockholder at all times relevant to this case. She was also a Zynga employee from 2009 until May 2011. On August 2, 2011, pursuant to a Stock Option Exercise Agreement (the "Exercise Agreement"), Lee acquired 30, 000 shares of Zynga stock at an exercise price of $3.805 per share. In September 2012, she sold substantially all of her stock at a price of $3.15 per share.
B. Zynga's Capital Structure
Zynga has three classes of common stock: (i) Class A shares, entitled to one vote per share; (ii) Class B shares, entitled to seven votes per share; and (iii) Class C shares, entitled to seventy votes per share, which "were issued only to Pincus." Zynga's publicly traded stock is its Class A shares. Except for matters that affect Class B or Class C shares differently, the three classes vote together on all matters submitted to Zynga stockholders, including the election of directors.
C. Zynga's Directors and Most Pre-IPO Stockholders Agree to Lockup Restrictions in Advance of the Company's IPO
On December 16, 2011, Zynga completed its IPO. It sold 100 million shares to the public at $10 per share, raising $1 billion. The offering price implied an enterprise value for the company of over $7 billion.
Before the IPO, the Director Defendants, Zynga's officers and employees, and most other pre-IPO investors (including plaintiff Lee) had agreed to lockup restrictions that prevented them from selling their Zynga stock for a 165-day period after December 15, 2011, i.e., until after May 28, 2012. Collectively, approximately 688 million shares—nearly seven times the initial public float—were subject to these lockup restrictions. The company disclosed the terms of the lockup restrictions in a Form S-1/A filed with the Securities and Exchange Commission on December 15, 2011 (the "December S-1"). According to the "Risk Factors" section of the December S-1, making additional Class A shares available to the public could "depress" the company's stock price.
Morgan Stanley and Goldman acted in the IPO as the lead underwriters and as the representatives for the other underwriters. In its IPO underwriting agreement with Morgan Stanley and Goldman, Zynga had agreed "[n]ot to amend, modify or terminate, or waive any provision of, any of the 'lock-up' agreements with [its] officers, ...