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FraudVille? Zynga sued for insider trading

July 31, 2012: 1:38 PM ET

Social gaming company faces class action lawsuit.

FORTUNE -- Zynga (ZNGA) and its bankers were hit with a class action lawsuit yesterday, accusing them of improperly allowing certain insiders to dump shares ahead of a disappointing earnings report.

Defendants include the social networking company, many of its senior executives, its entire board of directors (save for Ellen Simioff, who joined earlier this month) and bankers Goldman Sachs (GS), Morgan Stanley (MS), J.P. Morgan (JPM), Merrill Lynch (BAC), Barclays Capital (BCS) and Allen & Co.

The heart of the matter is an April 3 secondary offering of Zynga stock, which was priced at $12 per share. Sellers included company CEO Mark Pincus and chief operating officer John Schappert, even though their shares were supposed to be locked up for 165 days following Zynga's IPO. The original release date would have been May 28, but Zynga provided a special waiver that let them sell early. Or, more specifically, to sell before Q1 earnings were announced a few weeks later.

This is where things get a little bit murky. Zynga actually beat Q1 estimates, which would seem to work against the notion that company insiders were looking to dump shares ahead of bad news. Perhaps that's why the complaint barely mentions Q1, instead focusing on the disastrous Q2 earnings announced last week. And, if you're keeping track, Q2 would be the quarter that began just one business day before the share sale was completed (and several days after it began).

As of this writing, Zynga shares are trading at just $2.92 a piece.

Obviously, there is no way Zynga could have known its Q2 results on April 3. Moreover, the insiders could have sold their shares sans waiver before the Q2 earnings were announced, so this really is a question over whether the company intentionally doctored earnings forecasts. No evidence yet to suggest such a thing -- at least none presented in the complaint -- but plaintiff attorney Jeffrey Norton says that discovery may uncover emails or other communications that show the lousy prognostication was intentional.

It's also worth noting that the suit does not name any of Zynga's venture capital firms as defendants, even though several of them also sold shares in the secondary offering. Norton says that he did not have enough cause to include the firms, but that he may do so later if he finds that they received inappropriate information from Zynga executives, board members or bankers.

A Zynga spokeswoman declined to comment. Below is a copy of the complaint:

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Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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