Funds Stopped Playing Before the Game Got Ugly

By GRETCHEN MORGENSON
Fair Game
The New York Times
August 19, 2007

TAKE-TWO INTERACTIVE SOFTWARE, the maker of Grand Theft Auto, the shoot-’em-up video game, disclosed last week that it had received a Wells notice on Aug. 9 from the Securities and Exchange Commission, alerting the company to a possible enforcement action.

Take-Two said the notice relates to long-ago option grants that have been under scrutiny for months by the S.E.C. and Robert M. Morgenthau, the district attorney in Manhattan. Three former Take-Two executives pleaded guilty this year to falsifying records related to the options, a result of the investigation by Mr. Morgenthau’s office, which continues.

Well-timed option grants to executives have been a focus of investigators and journalists for the last year or so. But other, more recent developments at Take-Two are noteworthy: the recent selling by some big hedge funds that only last March got together to install new management at the company, and the suspicious trading just ahead of the company’s early August announcement that it could not deliver the newest version of Grand Theft Auto to stores this October.

The delay of the wildly awaited game has certainly hurt Take-Two. Throughout the year, its management repeatedly promised investors that the game would be delivered on time. It did so in April, in June and again on July 9.

But on Aug. 2, the story suddenly changed. Grand Theft Auto IV would be delayed until the second quarter of 2008 because extra development time was required, the company said after the close of trading. Take-Two’s stock fell 16 percent the next day and has declined further. It closed on Friday at $12.25, down 31 percent on the year.

Trading patterns, however, indicate that somebody may have known about the bad news ahead of time. Heavy sellers on Aug. 1 took Take-Two’s shares down almost 5 percent on more than double this year’s average daily trading volume. It was the heaviest trading in the company’s shares since the second-quarter earnings report.

ON an Aug. 2 conference call with investors to discuss the game’s delay, Strauss Zelnick, Take-Two’s chairman, said when asked about the suspicious trading that because the company is so closely watched and its game so anticipated, some leaks are normal. “Leaks aren’t wonderful,” he added. “Having said that, it’s not really the focus of our attention.”

Mr. Zelnick is right. It really is more of a regulator’s issue.

Perhaps more intriguing is the recent dumping of Take-Two shares by SAC Capital Advisors, run by Steven A. Cohen, and the Tudor Investment Corporation, overseen by Paul Tudor Jones. Documents filed by the two funds last week with the S.E.C. report sales they made in the second quarter of 2007. Both funds were involved in a boardroom coup that ousted Take-Two management and directors last spring, but they seem to be abandoning the very management and board they put in place.

Let’s go back to March 20, when Take-Two shares hit a high of $23.79. That was just three days before the annual shareholder meeting at which the company’s management and board were booted.

The removal was the work of three big hedge funds and one mutual fund that got together March 4 with the goal of bringing in a new broom to clean up the troubled Take-Two.

In the effort, SAC Capital and affiliates, which had amassed a 15.6 percent stake in Take-Two, much of it in January and February, and Tudor Investment and affiliates, with 18.7 percent, were joined by D. E. Shaw, a hedge fund, with 9 percent, and OppenheimerFunds, a longtime Take-Two investor, with 23.7 percent.

The foursome reported their collaboration to the S.E.C., as required, and on March 7, they said Mr. Zelnick, chief executive of ZelnickMedia, would lead the cleanup crew. Mr. Zelnick had run BMG Entertainment, the global music label, and 20th Century Fox, the movie studio. Since the funds controlled so many Take-Two shares, Mr. Zelnick was a shoo-in at the annual shareholder meeting on March 23.

Oddly, on April 2, shortly after the group put its new executive and directors in place, it disbanded. Usually, investors who install executives and board members stick around to watch them increase the values of their stakes.

Not SAC and Tudor. By June 30, SAC had dumped almost all its shares; only 10,300 shares remained, worth $123,000. In the same period, Tudor sold almost half its stake, leaving it with 1.9 million shares, valued at around $23 million. D. E. Shaw has not filed for the quarter; Oppenheimer still has a very large stake.

Had the funds gotten wind of problems with Grand Theft Auto IV when they dumped the huge stakes they had only recently amassed? Interestingly, while these professionals were selling their shares, takeover rumors regularly buoyed the stock.

Edward Nebb, a spokesman for Take-Two and Mr. Zelnick, said the funds could not have known because top management discovered only on Aug. 1 that the game was not ready. It told the public the next day. “The process of developing a game such as Grand Theft Auto IV is extremely complex,” Mr. Nebb said. “At some point, management had to make a decision to either ship a game that was not up to the Grand Theft Auto standards or to delay the launch until it was. And that point occurred immediately prior to the public disclosure on Aug. 2.”

So why did SAC and Tudor get out so quickly after they drafted Mr. Zelnick? Representatives for the funds and for D. E. Shaw declined to comment.

Then there is the timing of a recent grant to Mr. Zelnick. Under the terms of a management agreement made in March, he was to receive a large stock option grant at an unspecified date between June and late August. The grant was to be made at the prevailing market price.

The significant drop in Take-Two’s shares since the agreement was struck makes its grant date interesting. Had Take-Two given Mr. Zelnick his options in July, for example, they would have carried a strike price of around $20 a share, well above recent levels. But under an amended agreement made July 26, the stock option grant owed to Mr. Zelnick will now be struck on Aug. 27, reflecting the depressed prices related to the Grand Theft Auto IV delay.

The date is certainly within the time frame of the original agreement. But given that the amendment came on July 26, less than a week before Take-Two disclosed the game’s production delay, one wonders about the timing.

MR. NEBB said the board considered the date to be prudent.

“ZelnickMedia employees did not participate in the board of directors’ decision regarding the date of the option. Independent members of the board made the decision to set the date and announce it well in advance, and they chose Aug. 27, 2007,” he said.

Now Mr. Zelnick must deal with the disappointment of a delayed game and the missed revenue it would have produced in the latter part of the year.

Still, he is doing what he can to calm investors.

On Aug. 9, the day Take-Two received the Wells notice, Mr. Zelnick and other company officials were meeting with investors at an invitation-only event in Beaver Creek, Colo. The event, sponsored by Janco Partners, a brokerage firm in Greenwood Village, Colo., that has been a big bull on Take-Two’s shares, included a reception and dinner and, the next morning, a 45-mile bicycle trip to the Vail pass with Andy Hampsten, a former professional cyclist.

At least that pesky Wells notice didn’t ruin the fun.