Pyramid Holdings, Inc. v. Giant Interactive Group, Inc.
S.D.N.Y., filed Nov. 26, 2007
Case No. 07-CV-10588
I. Nature of the Case
This case is a federal securities class action on behalf of a group of Americans who purchased American Depositary Shares (“ADSs”) from Giant Interactive after the company’s initial public offering (“IPO”) on or about November 1, 2007 through November 19 2007. The group alleges violations of Sections 11 and 12(a)(2) of the Securities Act of 1933.


Giant Interactive is a developer who operates online games in the People’s Republic of China. The company’s most popular games are MMOs. It offers three successful MMO games: 1. Zheng Tu Online (“ZT Online”), a free-to-play RPG set in ancient China where players develop skills, use magical weapons, and team up with other players to fight monsters and players from other kingdoms; 2. ZT Online PTP, where players assume one of five different roles in 10 different kingdoms. PTP requires players to purchase physical or virtual prepaid game cards on an official website or Internet cafes; and 3. Giant Online, where players may assume one of 14 different roles spanning numerous regions. In this game, a player guides his or her character to develop skills and is encouraged to cooperate with other players to fight against players from other regions.


Two of the metrics that Giant Interactive reported for its games were the number of average concurrent users (“ACU”) and peak concurrent users (“PCU”). The rules of Giant Interactive’s games are material to investors because they impact the game play and the company’s ACU and PCU figures. The case here concerns a failure of Giant Interact to disclose a significant rule change to ZT Online (its most popular game).


On September 30, 2007, Giant Interactive completed its third fiscal quarter. A month and a half later (but before the company was required to publicly announce its third quarter earnings), Giant Interactive completed the IPO where the company sold 57 million ADSs, raising more than $886 million. The company announced that the underwriters had exercised their over-allotment option and purchased and sold an additional 8.6 million ADSs at $15.50 per share for an additional $133 million. Its total sales equaled $1.2 billion.


The Registration Statement, which incorporated a Prospectus, was issued in connection with the IPO, but, according to the complaint, contained inaccurate statements of material fact, and misrepresented or omitted the significant rule change to ZT Online that had resulted in declining ACU and PCU figures in the third quarter as opposed to the second quarter of 2007.


The Plaintiffs brought this class action seeking damages and recovery for the investment they had made as a result of Giant Interactive’s concealment of its declining figures because of the rule change. The Plaintiffs, as a class, presented the following questions of law and fact:
    1. Whether the federal securities laws were violated by Defendants’ acts


    1. Whether the Prospectus and Registration Statement issued by Defendants to the investing public in connection with the Offering omitted and/or misrepresented material facts about Giant Interactive and its business


    1. Whether Defendants’ statements issued during the Class Period were materially false and misleading; and


  1. The extent of injuries sustained by members of the Class and the appropriate measure of damages
II. Substantive Allegations


In the Registration Statement and Prospectus filed by Giant Interactive on October 31, 2007, Giant Interactive reported its ACU and PCU figures as increasing when, in fact, they were in the decline. The decline in ACU and PCU was attributable to a significant rule change implemented by Giant Interactive. The rule change discouraged “gold farming activities” in ZT Online. Gold Farming occurs when a MMO player attempts to acquire (‘farm’) items of value within a game, usually by performing some task for an indeterminable amount of time (e.g., killing an important creature). Generally, gold farming is conducted by companies that hire people to play these online games so they can generate online currency which they can then sell to third-party websites for real cash to actual players who will then use the gold coins in the game.


The Plaintiffs alleged that the Registration Statement for the third quarter did not explain or describe the gold farming rule change, did not highlight the negative trend in ACU and PCU, and did not disclose that the negative impact the rule change was having at the time of the IPO. They also claim that the Registration Statement was materially misleading because it omitted the significant effect gold farming activities had on Giant’s previous statistics despite the company’s knowledge of the pervasiveness of the activity.


While the Registration Statement did describe the gold coin currency system in ZT Online and alluded to the company’s efforts to “restrict” the ability of players to sell their gold coins, it failed to disclose that the company had changed the rules to restrict gold farming. In the Risk Factors-Risk Relating to Our Business and Industry-section of the Registration Statement the company described the negative effects of a rule change, but not the rule change relating to gold farming. The excerpted part read:


“To discourage this behavior, which we believe is inconsistent with the basic principles of our gameplaying environment, in May 2007 we changed the rules governing one of our popular promotions that enable a player to purchase virtual “insurance policies” for his or her character that would pay out virtual gold coins valued at up to five times the purchase price of the insurance policy once his or her character reached a predetermined experience level. Some players would use gold coins earned from these pay-outs to obtain virtual products, and then sell these virtual products to other players using auction websites. We changed the rule so that related pay-outs consist primarily of gold coin vouchers, which can only purchase virtual products that are non-transferable. We believe that this change was the main reason for the subsequent decrease in our monthly average concurrent users, which fell by 14.9% from 553,784 in May 2007 to 471,428 in June 2007.”


The Plaintiffs claim that under SEC rules, the Registration Statement was required to disclose that the company had materially changed the rules in ZT Online and that the rule change impacted the company’s continuing operations.


On November 19, 2007, Giant Interactive issued a press release announcing its financial results for the third quarter of 2007. The next day, in a Form 6-K, the company attributed the decrease in ACU and PCU to the June 2007 “gold farming rule.” That same day, Giant Interactive held a conference call with analysts and investors in which it attributed the decline in the third quarter to the rule change. Following the conference call, the price of Giant Interactive ADSs dropped from $14.88 to $11.10.


III. Count I—Violations of Section 11 of the Securities Act


The Plaintiffs alleged the following:
    • The Registration Statement for the IPO was inaccurate and misleading, contained untrue statements of material facts, and omitted necessary and material facts


    • Giant Interactive was responsible for the contents and dissemination of the Statement and the Prospectus and, as a result, were strictly liable for the misstatements and omissions


  • None of the Defendants made a reasonable investigation or possessed reasonable grounds for the belief that the statements in the Registration Statement were true or were not misleading
IV. Count II—Violations of Section 12(a)(2) of the Securities Act


The Plaintiffs, pursuant to Section 12(a)(2) of the Securities Act, 15 U.S.C. §771 claimed:
    • The Registration Statement contained a Prospectus which was used to induce investors to purchase Giant Interactive’s ADSs


    • That Giant Interactive solicited purchases for their personal financial gain through the preparation and dissemination of the Prospectus


    • The Prospectus contained untrue statements of material fact and omitted facts necessary to make the statements not misleading


    • That Defendants were obligated to make a reasonable and diligent investigation of the statements contained in the Prospectus to ensure that such statements were true


  • None of the Defendants made a reasonable investigation or possessed reasonable grounds for the belief that the statements contained in the Prospectus were accurate and complete
V. Prayer for Relief
The Plaintiffs sought the following judgment:
    1. Awarding Plaintiffs damages together with interest (for purchase of the ADSs)


    1. Awarding Plaintiffs their costs and expenses of litigation


  1. Awarding Plaintiffs further relief as may be just and proper under the circumstances
The Plaintiffs also asked for a jury trial. We will continue to track the case as it progresses.


If you are interested in learning more about the ZT Online, there is an interesting article written for the website DanWei that described the underpinnings of the game and the real-life gambling involved when playing. Also, an article on PlayNoEvil delves deeper into the way ZT Online differs from the normal MMO genre. It, too, was a fascinating read.
Walker Digital Sues 2K Games (Again)
Case Analysis: Sega v. MAPHIA