In re Giant Interactive Group, Inc. Sec. Lit.

643 F.Supp.2d 562

In re GIANT INTERACTIVE GROUP, INC. SECURITIES LITIGATION This Document Relates To: All Actions.

No. 07 Civ. 10588(RWS).

United States District Court, S.D. New York.

August 7, 2009.

COPYRIGHT MATERIAL OMITTED

Coughlin Stoia Geller Rudman & Robbins LLP, by: Mario Alba, Jr., Esq., Samuel H. Rudman, Esq., Melville, NY, Abraham Fruchter & Twersky LLP, by: Jack G. Fruchter, Esq., New York, NY, Brodsky & Smith, L.L.C., by: Even J. Smith, Esq., Mineola, NY, for Plaintiffs.

O'Melveny & Myers LLP, by: Jonathan Rosenberg, Esq., Lori E. Romley, Esq., Meredith N. Landy, Esq., Seth Aronson, Esq., Sidley Austin LLP, by: Alfred R. Pietrzak, Esq., Andrew S. Stern, Esq., Dorothy J. Spenner, Esq., Vikeena K. Bonett, Esq., New York, NY, for Defendants.

OPINION

SWEET, District Judge.

Defendants Giant Interactive Group Inc. ("Giant" or the "Company"), Merrill Lynch & Co. Inc. ("Merrill Lynch" or "Defendant Merrill"), and UBS Investment Bank ("UBS" or "Defendant UBS") (collectively, the "Defendants") have moved pursuant to Rule 12(b)(6), Fed.R.Civ.P., to dismiss the Consolidated Amended Complaint of Lead Plaintiffs Dunping Qui, Yihua Li, Xie Yong, Linming Shi, and Arthur Michael Gray (collectively the "Lead Plaintiffs"), alleging federal securities violations arising out of Giant's initial public offering on or about November 1, 2007 (the "IPO" or the "Offering").

Based upon the conclusions set forth below, the motion is denied.

I. PRIOR PROCEEDINGS

The initial complaint in this action was filed on November 26, 2007. By order of August 5, 2008, this and other actions were consolidated, and Lead Plaintiffs and counsel selected. The Consolidated Amended Complaint ("CAC") was filed on October 6, 2008, on behalf of all persons other than Defendants who purchased the American Depositary Shares ("ADSs") of Giant pursuant and/or traceable to Giant's IPO on or about November 1, 2007 through November 19, 2007, inclusive (the "Class Period"), alleging violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. §§ 77k & 77l (a)(2).

Defendants' motion to dismiss was heard and marked fully submitted on February 25, 2009.

II. PLAINTIFFS' ALLEGATIONS

The following allegations, taken from the CAC, are accepted as true for the purpose of resolving the motion to dismiss.

A. Defendant Giant Interactive

Giant describes itself as one of China's leading online game developers and operators and focuses on massively multiplayer online ("MMO") games. MMO games are played through networked game servers in which tens of thousands of players are able to simultaneously connect and interact. CAC ¶ 19.

Giant offers three MMO games, including ZT (or "Zheng Tu" in Chinese) Online, a free-to-play online two-dimensional role playing game set in ancient China. In ZT Online, players develop skills, use magical weapons and team up with other players to fight against monsters and players from other kingdoms. Free-to-play MMO games enable players to play the game for free, and the Company generates revenue by selling game points for in-game premium features such as virtual products and services to players. In addition to ZT Online, Giant offers ZT Online FTP, a pay-to-play game based on the ZT Online game, and Giant Online, another free-to-play military themed game. CAC ¶¶ 20-21.

Giant generates revenues from ZT Online from the sale of prepaid game cards which represent a specified amount of game points. The game points are registered to the purchaser's game account and are then used to purchase a virtual product or service in the game, e.g., a virtual shirt, a virtual potion or a virtual sword. Id. Revenues from ZT Online accounted for all of Giant's 2006 net revenues and nearly all of the Company's 2007 revenues. CAC ¶ 25.

The original metric used to assess an MMO game's revenue and popularity in a pay-to-play game was the subscription figure. CAC ¶ 26. However, in a free-to-play game such as ZT Online there are no subscription fees, and the number of users who open an account is unreliable as a measure of the game's popularity as there is no cost to play the game. Therefore, the key metrics for measuring and anticipating profitability are the peek concurrent users ("PCU") and average concurrent users ("ACU") statistics which measure the number of players logged onto the game at any one time. The more people actively playing the MMO games, the more game points they will purchase. Id.

B. The IPO

On or about October 31, 2007, Giant filed a Form F-1/A Registration Statement with the Securities and Exchange Commission ("SEC") for the IPO. On or about November 1, 2007, the Prospectus, which forms part of the Registration Statement, became effective and more than 57 million shares of Giant's ADSs at $15.50 per ADS were sold to the public, thereby raising more than $886 million. The Company sold 52,467,723 ADSs and Jing Shi, the daughter of Yuzhu Shi, Giant's chief executive officer and chairman, sold 4,729,700 ADSs in the Offering. An additional 8.6 million ADSs at $15.50 per ADS were sold when the underwriters exercised their over-allotment option. CAC ¶¶ 22-23. UBS and Merrill Lynch served as the lead underwriters and joint bookrunners for the IPO, and each purchased 22,521,486 ADSs from the Company. UBS and Merrill Lynch earned at least $45 million as a result of their sale of Company ADSs to public investors in the IPO. CAC ¶ 24.

In the Registration Statement, the Company highlighted the increases in ZT Online's PCU and ACU numbers, stating, in pertinent part:

ZT Online's compound quarterly growth rate was 39.6% and 45.3%, respectively, in terms of peak concurrent users and average concurrent users from the quarter ended March 31, 2006 through the quarter ended September 30, 2007.

CAC ¶ 28. Similarly, the Registration Statement contained a chart highlighting the Company's rising ACU and PCU trends. CAC ¶ 29.

According to Plaintiffs, however, Giant experienced a decline in its ACU and PCU figures between the second and the third quarter of 2007 as a result of a rule change designed to discourage "gold farming activities" in ZT Online. "Gold farming" is an activity in which a MMO game player attempts to acquire ("farm") items of value within a game, usually by exploiting repetitive elements of the game's mechanics. This is usually accomplished by carrying out in-game actions (such as killing an important creature) repeatedly to maximize gains and is generally conducted by companies that hire people to play online games so that they can generate online currency which is then sold on third-party websites for real cash to actual players who will then use the gold coins in the game. CAC ¶ 32.

Plaintiffs allege that although the Registration Statement contained the ACU and PCU figures for the quarter ended September 30, 2007, it failed to disclose the magnitude of the gold farming problem or that the ACU and PCU numbers were over-inflated by the inclusion of "gold farmers." CAC ¶¶ 31, 33. Plaintiffs also allege that the Registration Statement failed to explain or describe the rule change in any meaningful fashion, did not highlight the negative trend in ACU and PCU figures, and did not disclose the negative impact that the rule change was having at the time of the IPO. CAC ¶ 32.

On November 19, 2007, after the close of the market, Giant announced its financial results for the third quarter of 2007, the period ended September 30, 2007. CAC ¶ 39. Among other things, the Company reported that ACU for the third quarter was 481,000, a decrease of 6% from the second quarter of 2007, and that PCU for the third quarter was 888,000, a decrease of 17.2% from the second quarter of 2007. Id.

In a Form 6-K filed with the SEC on November 20, 2007, Giant attributed the decrease in ACU and PCU to a June 2007 game rule change instituted to discourage "gold farming" activities. CAC ¶ 40.

Also, on November 20, 2007, before the market opened, Giant held a conference call with analysts and investors to review its earnings release. CAC ¶ 41. During the conference call, Giant attributed the decline in the third quarter ACU and PCU figures to a rule change to ZT Online that was implemented in June 2007 to discourage gold farming activity. During the conference call, Giant's CEO described the pervasiveness of gold farming in the Chinese MMO game environment and its significance on ZT Online and online games in general. CAC ¶ 42. The following exchange took place:

OPERATOR: (Operator Instructions)

Your next question comes from the line of Gerard Sullivan, American Century. Please proceed.

GERARD SULLIVAN, ANALYST, AMERICAN CENTURY: Thank you. I wonder if you could just back up a little bit to me and talk about the—both the change in the game rules that discourage gold farming and I guess gold farming by that you mean sort of an experimental play or looking around or some kind, and why you did that, why that is good for the long term? I'm just curious if it doesn't discourage players to test the game and ultimately become payers. That's—so, I just wanted some clarification on it, thank you.

UNIDENTIFIED COMPANY REPRESENTATIVE: (Spoken in Chinese) Mr. Shi will answer the questions for you.

YUZHU SHI: (Spoken in Chinese)

UNIDENTIFIED COMPANY REPRESENTATIVE: (interpreted) First of all, it's actually quite a popular phenomenon in China. There are a lot of gold farming companies. They are pretty pervasive actually existing in all kinds of games in China.

YUZHU SHI: (Spoken in Chinese)

UNIDENTIFIED COMPANY REPRESENTATIVE: (interpreted) We actually are seeing great damage from this group of companies.

YUZHU SHI: (Spoken in Chinese)

UNIDENTIFIED COMPANY REPRESENTATIVE: (interpreted) Especially in free-to-play type of games, their existence actually generated artificially inflated supply in terms of the gold coin or the virtual currency in games. That actually creates the inflation within the game.

YUZHU SHI: (Spoken in...