When Zynga went public in December of 2011 at $10 a share, employees and early investors were "locked up," banned from selling their shares until May 28th, 2012. But a select group of insiders got underwriters Morgan Stanley and Goldman Sachs to waive that restriction, allowing them to sell an additional $515 million worth of shares on April 3rd at $12 a pop.

This arrangement is at the heart of an insider trading lawsuit filed yesterday in San Francisco by the law firm Newman Ferrara. "Zynga's regular employees were still locked up from selling their shares. But the guys at the top, who saw what was coming down the pipe, got to cash out," said Ferrara attorney Roy Shimon. By the time the original lockup expired on May 28th, the company's share price had dropped to $6. After last week's earnings report it dropped to just over $3.

It's not easy for employees to see that the executive team were selling their shares while most people were still locked up

There are now five law firms who have announced investigations into insider trading at Zynga, with Newman Ferrara the first reported to file. All will be competing to get large investors as their clients, as the final case will eventually be consolidated behind a lead plaintiff who represents the biggest shareholders. If the case proceeds, lawyers will be seeking access to emails and other internal documents to learn how much company insiders knew about the health of Zynga's business and when. If they had information that the company's results would be so poor, and failed to disclose that to the public before selling, then a case can be made for insider trading.

Avoiding the lockup allowed executives to sell at a time when Zynga had been issuing positive outlooks on its business, operations, and growth prospects, such as significantly higher bookings projections for the second half of 2012. When the secondary offering was first reported in March, Zynga said that it hoped to "facilitate an orderly distribution of shares and to increase the company’s public float." The rationale given by the company was that it was better to stagger the sale of shares, rather than wait for everyone to sell at the same time in late May. A Zynga employee who asked to remain anonymous said the situation was hard on morale. "It's not easy for folks to see that the executive team were selling their shares while most people were still locked up."

The secondary offering in April, technically during the company's second quarter, was the first time that executives like CEO Mark Pincus had a chance to sell their shares. Pincus unloaded 16.5 million class B shares, or about 15 percent of his total holdings. Zynga's chief operating officer and chief financial officer, along with early investors like Institutional Venture Partners and Union Square Ventures, also sold. The banks who acted as underwriters for the April transaction received $15 million in fees.

After its shockingly poor second quarter earnings became public, Zynga blamed delays in the release of new games like The Ville, a more "challenging environment" promoting its games on Facebook, and the poor performance of recent acquisition, Draw Something. But employees said it would be hard to imagine the executives not seeing warning signs. "Zynga is a company very focused on data. Mark (Pincus) wants this business to be driven by numbers, not by hits," said one employee. "They analyze every action in the game and try to optimize the business. The rely on franchises to eliminate risk."

Avoiding the lockup allowed executives to sell, at a time when Zynga had been issuing positive outlooks

Henry Blodget writes that, "I know many of these folks personally, including at the company's underwriters, and like and respect them. I think the last thing they would intentionally do is unload stock when they thought it was about to crash—especially when the amount they made in the sale, though huge, is still relative chicken feed for them. Also, all of these folks only sold a fraction of their holdings, so they've been hammered along with the rest of Zynga shareholders by the subsequent collapse."

But while Mr. Pincus sold only a fraction of his total holdings, other executives sold far more. According to this New York Times piece, COO John Schappert sold 45 percent of his shares and Zynga's chief financial officer, David Wehner, sold more than half of his stock.