Joseph Zerger, Et Al. V. Midway Games, Inc., Et Al. 07-CV-03797
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UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION JOSEPH ZERGER, On Behalf of Himself and Case Number 07 C 3797 All Others Similarly Situated, ) (Consolidated) Plaintiff, vs. MIDWAY GAMES INC., et al., Defendants. DEMAND FOR JURY TRIAL CONSOLIDATED AMENDED CLASS ACTION COMPLAINT FOR VIOLATION OF THE SECURITIES LAWS The Court-appointed Lead Plaintiffs, Andre Pappas and Giancarlo Dimizio, individually and on behalf of all persons similarly situated (collectively, "plaintiffs ), by and through their undersigned attorneys, file this Consolidated Amended Class Action Complaint for Violation ofthe Securities Laws against Midway Games, Inc. ("Midway or the "Company ), Steven M. Allison, James R. Boyce, Miguel Iribarren, Thomas E. Powell and David F. Zucker (collectively, the "Individual Defendants or, together with Midway, the "defendants ). Plaintiffs allege the following based upon the investigation ofplaintiffs' counsel, which included a review of Midway's and other entities' and individuals' filings with the United States Securities and Exchange Commission ("SEC ), as well as regulatory filings and reports, press releases and other public statements issued by the Company and other individuals and entities and media reports about the Company. Plaintiffs believe that substantial additional evidentiary support will exist for the allegations set forth herein after a reasonable opportunity to conduct discovery. INTRODUCTION & OVERVIEW 1. This is a securities class action on behalf of all purchasers of the common stock of Midway between August 4, 2005 and May 24, 2006 (the "Class Period ), seeking to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange Act or the "1934 Act ) 2. Midway develops and publishes interactive entertainment software for the global video game market. The Company has been in the business of creating video games for more than 20 years and has published over 400 titles. In 2001, Midway's management decided to focus exclusively on the home console and handheld video game software market and get out of the coin- operated product business. The Company's products are available for play on major platforms, including Microsoft's Xbox, Nintendo's GameCube and Game Boy Advance and Sony's PlayStation 2 and PlayStation Portable. Midway focuses its product development efforts on the creation of numerous titles across many of the most popular video game genres. -1- In February 2005, Midway announced Q4 2004 net income of $17 million on $77 million in revenues - its first profitable quarter in five years. A large part of the Company's Q4 2004 financial results was based on the successful release ofthe games Mortal Kombat -Deception and Arcade Treasure 2, and the ability to keep costs in check. Indeed, Midway's ability to deliver positive financial results to the market in the future would be dependent upon the Company's successful release of new game titles on diverse platforms in a cost efficient manner. Another objective of Midway's future success was reasonable growth in its product development infrastructure: including the ability to attract and retain the highest quality product developers. Achieving these objectives proved costly during the Class Period and required funding from either internal cash flow or the capital markets. 4. At Midway, however, internal funding of expensive product development projects was generally out of the question. After a profitable Q4 2004, Midway failed to generate a single penny of net income , which necessitated the Company to obtain cash from the capital markets (i.e., external sources) to fund the day-to-day operations ofthe business. For instance, the Company had borrowed $75 million in September 2005 to fund the business. But given the large operating losses Midway was generating during 2005, coupled with the expenditure oftens of millions of dollars for product development each quarter, the Company would find itself needing cash again, and quick. During 2005, the Company's product development strategy for the major platforms was to "internally develope[] products due to the favorable profit margin contribution and the ability to leverage ... products into sequels and derivative products. Midway also produced games for the personal computer ("PC ) market segment during 2005, even though the market was not a major target of the Company's business at that time. Accordingly, rather than do PC-based product development in-house, during most of 2005 Midway contracted the work out to other development companies. -2- 6. Throughout the Class Period, Midway bolstered its team of internal product developers. Defendants repeatedly informed the market that "robust internal product development resources will be a critical advantage to Midway in the future. To that end, between December 31, 2003 and December 31, 2005, Midway increased its internal product development team from 330 to 650 employees. Midway made these gains in internal product development headcount largely through hiring product developers and the acquisition ofcompetitors in the interactive entertainment industry, such as Ratbag Holdings Pty Ltd. ("Ratbag, acquired in August 2005) and The Pitbull Syndicate Ltd. ("Pitbull, acquired in October 2005). 7. Midway's sustained investment in internal product development infrastructure was a significant drain on the Company's capital resources - much more costly than defendants let on during the Class Period. Throughout the Class Period, defendants repeatedly represented that Midway had sufficient working capital - i. e., cash - to fund the operations of the Company and its continued product development investments. Defendants also touted the acquisition of Ratbag product developers as adding depth to the Company's internal product development organization and strengthening Midway's ability to deliver commercially successful products to customers. 8. None ofdefendants' representations were true, however. Defendants concealed from the market that they did not intend to keep Ratbag's product developers because Midway sought to acquire the business's customer base, not its products. In fact, defendants wound down the operations of Ratbag four months after announcing its acquisition. As a result of defendants' undisclosed strategy, Midway incurred approximately $13 million in restructuring charges during 2005 to account for the closing of Ratbag. The $13 million in restructuring costs announced by the Company on December 16, 2005 created additional funding needs since Midway had been consistently operating at a loss and foresaw continued losses in guidance provided to the market. -3- 9. In November 2005, Midway cancelled a contract with Stainless Steel Studios ("Stainless Steel ), who the Company had hired to develop the PC-based game entitledRise & Fall: Civilizations of War ("Rise & Fall ). As a result, defendants concealed that Midway would be forced to invest millions of dollars of additional internal product development resources for PC- based products between November 2005 and June 2006. Like the $13 million in restructuring costs incurred with the closure of Ratbag, these additional investments created additional funding needs since Midway had been consistently operating at a loss and forsaw continued losses in guidance provided to the market. 10. As a consequence of defendants' closure of Ratbag and the cancellation of the Stainless Steel contract, the Company incurred, and would continue to incur, millions of dollars of incremental costs. The undisclosed reality was that the Company would soon be forced to tap the capital markets for a highly dilutive debt offering to fund Midway's day-to-day operations. The Individual Defendants took full advantage of this undisclosed reality - selling 782,950 shares of their Midway stockforproceeds of$15.3 million . 740,450 of the total shares, and $14.7 million of the total proceeds, were sold and obtained injust 18 days - between December 19, 2005 and January 6, 2006. 11. The Individual Defendants' unusual and suspicious insider trading is made all the more suspect by the fact that 490,450 of the total shares, and $10.3 million of the total proceeds, were sold and obtained between December 19, 2005 and December 29, 2005. On December 29, 2005, Sumner Redstone ("Redstone ) (the controlling shareholder ofMidway) publicly announced that he had pledged over 33 million Midway shares to collateralize a personal loan with Citicorp. 12. Prior to and during the Class Period, Redstone, either directly or through other entities and representatives, reported that he was undergoing an evaluation of taking Midway "private and that Viacom considered Midway a potential acquisition candidate. At the same time -4- Redstone was reporting this information to the market, he was acquiring large sums ofMidway stock in open market transactions. 13. The market considered the information regarding Redstone important: March 1, 2005 - Wedbush Morgan Securities: Although we are quite optimistic about the company's turnaround, we continue to view Midway shares as somewhat overvalued. We are confident that Midway's share price appreciation over the past year is in large part attributable to the massive purchases of stock by Viacom (VIA - Not Rated) Chairman Sumner Redstone. March 23, 2005 - Wall Strategies: [T]here are some concerns, the most prevalent being Sumner Redstones [sic] presence. On our prior update on January 4, Mr. Redstone owned 70% ofMidway's shares, now he owns 77% .... [I]f Redstone decides that Midway is not