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Lawrence F. Glaser, On Behalf of Himself and All Others Similarly v. The9

March 28, 2011

LAWRENCE F. GLASER, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFF,
v.
THE9, LTD., XIAOWEI CHEN, GEORGE LAI, AND ORDER HANNAH LEE, TONY TSE, AND JUN ZHU, DEFENDANTS.



The opinion of the court was delivered by: Richard J. Holwell, District Judge:

MEMORANDUM OPINION

Lead Plaintiffs Lawrence F. Glaser and Chen Kuang bring this putative class action against defendants The9 Ltd. ("The9"), Xiaowei Chen, George Lai, Hannah Lee, Tony Tse, and Jun Zhu, alleging violations of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), Exchange Act Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and Exchange Act Section 20(a), 15 U.S.C. § 78t(a). Plaintiffs allege that between November 15, 2006, and July 15, 2009 (the "Class Period"), defendants fraudulently misrepresented facts relating to the likelihood of their renewal of a certain extremely profitable exclusive license granted them by a third company. Defendants now move to dismiss. For the reasons set forth below, and specifically because plaintiffs fail to adequately plead scienter, defendants' motion is GRANTED in its entirety; and plaintiffs are granted leave to replead their complaint.

I. FACTUAL SETTING

For the purposes of the present motion, the following facts-drawn from the complaint, documents incorporated by reference therein, Securities Exchange Commission ("SEC") public disclosure documents, and documents known to the plaintiffs and upon which they relied in bringing this action*fn1 -are taken as true.

A. Background

Lead Plaintiffs Lawrence F. Glaser and Chen Kuang seek to represent the class of persons who purchased The9's American Depositary Shares ("ADS") and options during the Class Period, November 15, 2006, through July 15, 2009. (Compl. ¶¶ 15, 23.) Defendant The9, incorporated in the Cayman Islands with its principal place of operations in China, operates multiplayer online video games*fn2 in China. (Id. ¶ 16; Def.'s Mem. at 3.) The9's stock trades as ADS on NASDAQ. (Compl. ¶ 16.) As relevant to this action The9 contracts with video game developers, such as non-parties Blizzard Entertainment Inc. ("Blizzard") and Electronic Arts, Inc. ("EA"), to provide and run the networks and servers on which those developers' multiplayer online video games are played. (See id. ¶¶ 29, 34, 52.) Defendant Jun Zhu is a co-founder of The9, and was the company's Chief Executive Officer ("CEO") during the Class Period. (Id. ¶ 17(a).) Defendant Hannah Lee was The9's Chief Financial Officer ("CFO") and Vice President ("VP") from January 2004 through February 2008. (Id. ¶ 17(b).) Defendant Tony Tse followed as The9's CFO through June 2008. (Id. ¶ 17(c).) Defendant George Lai was

The9's CFO from July 2008 through the end of the Class Period. (Id. ¶¶ 1, 17(d).) Defendant Xiaowei Chen was The9's President from May 2008 through the end of the Class Period. (Id. ¶ 17(e).)*fn3

On February 3, 2004, The9 entered into a contract (the "WoW Contract") with Blizzard's parent company, Vivendi Universal Games ("Vivendi"), to be the exclusive operator of Vivendi's game World of Warcraft*fn4 ("WoW") in China. (Id. ¶ 29.) The WoW Contract, which was amended in January 2007 to replace Vivendi with Blizzard, was to expire on June 7, 2009. (Id. ¶¶ 29-30.) The9 launched WoW in China on June 5, 2005; and in the third quarter of 2005, The9's revenues rose 2,096% to $22.8 million. (Id. ¶¶ 29, 32.) Of that amount, The9 attributed $22.3 million to WoW. (Id. ¶ 32.) WoW would go on to account for over 90% of The9's revenues in 2006, 2007, and 2008. (Id. ¶16.)

In March 2006, a gaming news website reported that tensions had arisen between The9 and Blizzard over whether operation of WoW's first expansion pack, Burning Crusade, was included in the original deal. (Id. ¶ 36.) And in April 2006, The9 contracted with NCsoft Corporation ("NCsoft") to operate NCsoft's game Guild Wars, a competitor of WoW, in China. (Id. ¶ 37.) Later in April, a different gaming news website reported its belief that Blizzard would "evaluate" partners other than The9 for operation of WoW in China. (Id. ¶ 38.) Moreover, plaintiffs' Confidential Witness One ("CW1")*fn5 , a Blizzard employee in 2005 and 2006, alleges that Blizzard was displeased with The9's overall handling of WoW and that Blizzard expected WoW to generate larger revenues in China than it had. (Id. ¶ 39.) Plaintiffs claim these tensions "increas[ed] the likelihood that The9 would not renew the WoW Contract when it was set to expire in June 2009." (Id.)

B. The Class Period

1. Alleged Misstatements and Omissions During the Class Period

The Class Period begins on November 15, 2006 and ends on July 15, 2009. (Id. ¶¶ 1, 43.) Plaintiffs allege that defendants, specifically Zhu and Chen, made fraudulently misleading statements during that period that fall generally into three categories. The first category consists of statements allegedly indicating defendants' beliefs that renewal of the WoW Contract was likely. The second is made up of statements allegedly representing either that The9's relationship with Blizzard was good, or that that relationship had not deteriorated as indicated by various online rumors. The last category consists of statements to the effect that The9's prospects for growth were optimistic.

On November 16, The9 released its third quarter 2006 financial results and held a conference call. (Id. ¶¶ 43-44.) Before the call, The9's Investor Relations ("IR") Manager, stated:

Before we start I would like to read you the Safe Harbor statement. During the course of today's call certain projections or forward looking statements may be made regarding The9's future financial performance or future events. We wish to caution you that such statements or predictions are based on current information and expectations and actual results may differ materially from those projected in the forward looking statements.

We would also like to refer you to documents that the Company has filed with the [SEC]. These documents contain additional information concerning factors that could cause actual results to differ materially from those contained in the management's projections or forward looking statements. (Kutcher Decl. Ex. 23 at 2 (this passage, stated as above, is hereinafter referred to as "The9's Conference Call Safe Harbor Statement").)

During the November 16, 2006 call, an analyst asked Zhu when Zhu expected Burning Crusade-the WoW expansion pack-to launch in China and whether The9 and Blizzard had had any "new negotiations" regarding Burning Crusade. (Compl. ¶ 44.) Zhu replied that the companies had "always believed that Burning Crusade is part of our original licensing agreement," and that "[d]uring the four years of exclusive license there's no possibility that a company other than The9 can operate Burning Crusade in China." (Id.) Zhu went on to say that The9 and Blizzard were "active in discussion" concerning "the marketing arrangement and the timetable for the Burning Crusade in China," and that "we'll continue to communicate with them in the coming two and a half years." (Id.) Plaintiff alleges those statements were false and misleading because they misrepresented or failed to disclose that (i) there were tensions between The9 and Blizzard . . . ; (ii) there was a significant undisclosed risk that The9 would not be able to renew the WoW Contract . . . ; (iii) the Individual Defendants and other Company insiders understood that there was likely a finite amount of time to financially benefit from WoW; and (iv) the Individual Defendants and other Company executives engaged in a scheme to personally benefit from WoW before the expiration of the WoW Contract. (Id. ¶ 45.) The9's ADS increased from $4.92 to $28.36, a twenty-one percent rise, on November 16. (Id. ¶ 47.) At the same time, Incsight, Ltd. ("Incsight"), a company owned by Zhu sold 86,499 shares of The9 for about $2.37 million between November 15 and November 24, 2006, at an average price of approximately $27.42 per share. (Id. ¶¶ 17(a), 48, 148.)

Despite alleged appearances, however, according to CW4, a former executive at The9, "Zhu told Company executives in early 2007 that he viewed it as very unlikely if not impossible for The9 to be able to renew the WoW Contract." (Id. ¶ 40.) CW4 also claims that "Zhu understood that The9's relationship with Blizzard had been 'ruined' by early 2007." (Id.) In addition on May 21, 2007, EA, a competitor to Blizzard in the video game development industry, purchased 15% of The9's shares for $167 million. (Id. ¶ 52.) EA also granted The9 the exclusive right to publish one of EA's games, FIFA Online, a multiplayer online soccer video game, in China. (Id.) CW2, a licensing manager at Blizzard during this period, alleges that "'loyalty' was important for Blizzard and the investment by EA in The9 would have been viewed as The9 not being loyal to Blizzard." (Id. ¶ 53.)

Zhu addressed the EA investment, among other issues, on a May 22, 2007 conference call announcing The9's first quarter 2007 earnings. As with the November 16, 2006 call, the IR Manager stated The9's Conference Call Safe Harbor Statement at the start of the May 22, 2007 call. (Kutcher Decl. Ex. 25 at 1-2.). Later on the call Zhu stated, "we believe The9 is well positioned for sustainable growth." (Compl. ¶ 56.) Zhu also denied that EA's investment would "have any impact on our relationship with Blizzard" because the companies' games were focused on different genres. (Id. ¶ 57.) Finally, to an analyst's question about the possibility of extending the WoW Contract past June 2009, Zhu said, "the relationship between [Blizzard and The9 is] very good, but currently we haven't talked about things beyond '09." (Id. ¶ 59.) The9's ADS increased $4.76, or 12%, to $44.23 on May 22. (See id. ¶ 62.) The ADS reached a Class-Period high of $51.97 on July 13, 2007. (Id. ¶ 64.) Despite the alleged additional misstatements detailed below, however, the ADS' price declined, at first dramatically and then steadily, through the end of the Class Period, July 15, 2009. The9's ADS traded in the mid-$45 range in August 2007; in the $30s in October 2007; at $25 by the end of November 2007; around $20 in January and February 2008; near $25 in May 2008; around $18 and $19 in August and September 2008; at $13 in April 2009 before Blizzard announced that it would not renew the WoW contract with The9; at $10 directly after that announcement; and at $8.68 at the Class Period's close in July 2009. (Id. ¶¶ 65, 75, 83, 85, 90, 97, 106, 110, 157, 159.)

On June 28, 2007, The9 filed its Form 20-F*fn6 for the fiscal year ending December 31, 2006, with the SEC. The9 Limited, Annual Report (Form 20-F) (June 28, 2007) (hereinafter the "Fiscal 2006 20-F"); (see also Kutcher Decl. Ex. 4.) Therein under "Risk Factors" The9 noted (1) its "limited relevant operating history," which makes it "difficult to evaluate our prospective business," (The9 had formed in 2000 and only launched its first MMORPG in February 2003); and (2) the "potential failure[s]" to "successfully launch and operate new online games licensed to us," or to "license . . . additional online games." In addition, specifically concerning risk factors related to WoW, the Fiscal 2006 20-F stated

If we are unable to maintain a satisfactory relationship with Blizzard or any other online game developer that has licensed a game to us, or if Blizzard or any of our other online game licensors either establishes similar or more favorable relationships with our competitors in violation of its contractual arrangements with us or otherwise, our operating results and our business would be harmed, because our business depends significantly upon our exclusive licenses to operate WoW . . . . [W]e cannot assure you that Blizzard or any of our other online game licensors will renew its license agreement with us . . . . Any deterioration of our relationship with Blizzard or any of our other online game licensors could harm our future results of operations or the growth of our business. Fiscal 2006 20-F at 9.

On August 3, 2007, reports again surfaced of rumors on gaming websites concerning tensions between Blizzard and The9. (Compl. ¶ 67.) According to the news articles, however, Blizzard and The9 jointly announced that "'[t]he media reports of disagreements between The9 and [Blizzard] are groundless, . . . [Blizzard] and The9's cooperation has been smooth and friendly.'" (Id. ¶ 68 (quoting the article quoting the joint announcement).) Then on August 29, The9 released its second quarter 2007 financial information and an accompanying press release, stating, "with all the [] high-caliber games to be launched in the future, we are confident that The9 will continuously capitalize on its unparalleled game portfolio so as to achieve long-term sustainable growth." (Id. ¶ 71.) The August 29 press release contained a safe harbor statement similar to those stated at the start of the conference calls, but which also specifically included that "forward-looking statements can be identified by terminology such as 'will,' 'expects,' 'anticipates,' 'future,' 'intends,' 'plans,' 'believes,' 'estimates' and similar statements." (Kutcher Decl. Ex. 14 at 11.) The safe harbor provision went on:

A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Potential risks and uncertainties include, but are not limited to, The9's limited operating history as an online game operator, political and economic policies of the Chinese government, the laws and regulations governing the online game industry, information disseminated over the Internet and Internet content provides in China, intensified government regulation of Internet cafes, The9's ability to retain existing players and attract new players, license, develop or acquire additional online games that are appealing to users, anticipate and adapt to changing consumer preferences and respond to competitive market conditions, and other risks and uncertainties outlined in The9's filings with the [SEC]. (Id. (this passage, stated as above, is hereinafter referred to as "The9's SEC Filing Safe Harbor Statement").)

The9 launched the WoW expansion pack, Burning Crusade, in September 2007. (Compl. ¶ 75.) Then on November 16, 2007, The9 released its third quarter 2007 financial results and held a conference call. Like the November 16, 2006, and May 22, 2007 calls, this call began with the IR Manager reading The9's Conference Call Safe Harbor Statement. (Kutcher Decl. Ex. 26 at 1.) Later in the call, Zhu responded to an analyst's question about extending the WoW Contract. Zhu said, "after [Burning Crusade] was launched we started discussions with [Blizzard] regarding the renewal of the contract as you mentioned. But so far we don't have any comment. But we are very confident to eventually renew the contract of WOW with Blizzard." (Compl. ¶ 77; Kutcher Decl. Ex. 26 at 7.)

Lee resigned as The9's CFO on January 18, 2008, and was replaced by Tse. (Compl. ¶¶ 17(c), 85.) On February 22, 2008, The9 released its fourth quarter 2007 financial results and held a conference call. As with the prior conference calls, the IR Manager read The9's Conference Call Safe Harbor Statement. (Kutcher Decl. Ex. 27 at 2.) Later, in response to an analyst's questions regarding license renewal, Zhu stated, "WoW has been in very strong growth during the past few years and also we are always in very good [sic] relationship with Blizzard. . . . So I was very confident that we believe that we can renew the contract in '09." (Compl. ¶ 88.) Then, when The9 held a conference call to release its first quarter 2008 financial results on May 20, 2008, also preceded by a reading of The9's Conference Call Safe Harbor Statement, an analyst again asked about developments in renewal negotiations. (Kutcher Decl. Ex. 28 at 1-2, 13.) The9's President, defendant Chen, answered, "our current license will expire in June 2009 and we have been in very close discussions with Blizzard and Blizzard's headquarters, about extension of the license. This is all I can tell you. That the discussions are ongoing and very intense and that's all I can tell you." (Compl. ¶ 94.)

Tse resigned as The9's CFO on June 7, 2008, and was replaced by Lai. (Id. ¶ 98.) Then on June 30, 2008, The9 filed its Form 20-F for the fiscal year ending December 31, 2007. The9 Limited, Annual Report (Form 20-F) (June 30, 2008) (hereinafter the "Fiscal 2007 20-F"); (see also Kutcher Decl. Ex. 5.) In highlighting risks similar to those mentioned in the Fiscal 2006 20-F, the document stated,

[the WoW Contract] will expire on June 7, 2009. Since the launch of WoW in June 2005, we have derived substantially all of our revenues from WoW. If we are unable to renew this license . . . our future results of operations will be materially adversely affected. We intend to vigorously pursue negotiations for the renewal of the WoW license, which negotiations are currently underway.

Fiscal 2007 20-F at 6. The form went on to detail the risk presented by potential deterioration of The9's relationship with Blizzard, previously mentioned in the ...


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