A high-drama and high-stakes ScamVille exchange over the weekend left Zynga in the penalty box. Facebook put their newest social game, FishVille, on ice for advertising violations. In response, Zynga said they’d pull down all advertising offers until further notice.

Zynga’s now saying that the game will be live again at midnight tonight. 875,000 users flocked to the aquarium game in its first two days, so I’m sure they’ll be glad to see it back.

And so far Zynga has lived up to its recent promise. All offers, including legitimate ones like virtual currency for Netflix subscriptions, have been removed from all Zynga games.

Last week Zynga CEO Mark Pincus said that they would take steps to remove scammy advertising offers from their social games. There have been a couple of missteps since then, and Facebook responded by taking Zynga’s newest game, FishVille, offline.

Zynga insists they are serious about cleaning up the industry. And today Pincus has announced that the company will remove all offer advertising from their games.

This isn’t a meaningless action. Offers account for 1/3 or so of Zynga’s rumored $250 million in revenue.

All offers will be removed by the end of today, says Pincus, “until we can control their inclusion and presentation ourselves.”

The blog post also discloses that Zynga is an investor in DoubleDing, an offer provider that competes with OfferPal and SuperRewards. DoubleDing was serving the mobile offers that popped back onto Zynga on Friday.

Pincus’ blog post:

Zynga’s most recent Facebook game, FishVille, has temporarily been taken offline by Facebook for advertising violations.

FishVille will remain suspended, Facebook tells us, “until Facebook is satisfied that Zynga demonstrates compliance with Facebook restrictions — as well as Zynga’s own restrictions — on the ads it offers users.”

This is a relatively light slap on the wrist since the game only launched two days ago and had a couple of thousand users (Update: Zynga says FishVille had 875,000 users yesterday. wow). Zynga’s other games, including FarmVille with 63 million monthly users, remain online, despite the fact that they were showing the same ads.

But this does send a clear message to Zynga and other game developers that Facebook isn’t ignoring the problem. Whether it’s a real concern over the user experience or simply embarrassment from the press suggesting Facebook is a haven for scammers is somewhat irrelevant.

Facebook has also shut down a total of four ad networks in recent months for ad violations, including Tatto Media and Gambit. Other networks, such as SendMe Mobile, which was founded by ex-CNET executives, have largely taken their place by offering similarly questionable offers that trick users into mobile subscriptions.

This is also a bit of an arms race. Zynga may be specifically filtering Facebook employees from seeing ads that violate Facebook terms and conditions, making it difficult for Facebook to enforce the rules.

And the relationship between the two companies is complicated. Facebook battling Zynga on the advertising scams. But Zynga is also one of Facebook’s largest advertisers, probably accounting for between 10% and 20% of total Facebook revenue.

Just five days ago Zynga CEO Mark Pincus said mobile subscriptions, among other scammy offers, would be removed from Zynga’s popular Facebook and MySpace games. “We have also removed all mobile ads until we see any that offer clear user value,” he said.

So we were surprised yesterday to see a screen shot clearly showing a mobile subscription ad in a post on InsideSocialGames about the launch of a new Zynga game, FishVille.

I went to the game to check myself, but those mobile ads weren’t there. I assumed they had quickly been taken down, or there was some other reasonable explanation.

They weren’t taken down though. Or rather, they were, but just for me. Other users were still seeing the same mobile ads. And the filtering was clearly directed at me, since I logged in on the same IP address with a friends account and saw the ads. I held a laptop showing the ads up next to my screen that didn’t show the ads and took a picture:

Zynga CEO Mark Pincus said earlier this week that he intends to make sure his company’s games don’t include scammy offers in the future. Our full background on this story is here.

But what he didn’t say in that blog post is that Zynga has been scamming users from the beginning quite intentionally as part of their revenue model. Rather, he pointed much of the blame at middlemen offer companies: “We need to be more aggressive and have revised our service level agreements with these providers requiring them to filter and police offers prior to posting on their networks.”

Last spring, though, he gave a much clearer explanation to an audience at a Startup@Berkeley mixer, admitting that scamming users was part of Zynga’s business model from the start. And it was all caught on video. I think everyone sort of knew that this was exactly Zynga’s gameplan. But to hear it said so directly is just shocking.

The full 30ish minute video is here. We’ve taken the relevant section of the video, roughly starting at around the 10:40 mark, and embed it below. From the video:

I knew that i wanted to control my destiny, so I knew I needed revenues, right, fucking, now. Like I needed revenues now. So I funded the company myself but I did every horrible thing in the book to, just to get revenues right away. I mean we gave our users poker chips if they downloaded this zwinky toolbar which was like, I dont know, I downloaded it once and couldn’t get rid of it. *laughs* We did anything possible just to just get revenues so that we could grow and be a real business…So control your destiny. So that was a big lesson, controlling your business. So by the time we raised money we were profitable.

Zynga changed their lead gen scam policy this morning (the whole Scamville background is here, see updates at bottom as well). And now RockYou is taking steps to clean up their act to, according to an email we’ve been forwarded.

In an email to RockYou’s publishers, they say that they will begin complying with Facebook’s rules on offer scams (and like you, we’re not sure why they haven’t been complying all along, but lax enforcement is likely the cause).

Two interesting nuggets from the email though. First, RockYou says that from now on you’ll only see “clean, safe surveys from top tier brands advertisers.” All of the surveys we’ve seen are mobile subscription scams, so I’m not sure there’s such a thing as a clean, safe survey.

Second, the email says “the Facebook compliance team will be keeping a very close eye on offer walls starting tonight.” We’d heard that Facebook is coming down hard on app developers around scams right now, but Facebook won’t comment about it other than to say that they have always been monitoring application offers and enforcing the rules. From what we’ve seen, that enforcement didn’t bring much in the way of results, but perhaps they’re more serious about the situation now.

The full email:

Well that didn’t take long. We outlined the not-so-ethical ways that the big social gaming startups are generating revenue through lead gen scams and subscriptions through a series of posts over the last week. Starting with Social Games: How The Big Three Make Millions and Scamville: The Social Gaming Ecosystem Of Hell. We also threw in some comments by other companies and a former scammer, and a quote from Zynga that 1/3 of their revenues come from offers, much of which are scams.

We thought this would be a fight that would take months to end successfully, and we thought that only Facebook or MySpace would make the move to clean up their own platforms.

But boy am I surprised today to see Zynga, the worst of the offenders, admit publicly to the problem and take quick steps to change. CEO Mark Pincus says:

Michael Arrington posted over the weekend about CPA offers within social games and questioned why facebook, myspace, zynga and others would expose these to our users. He raises good points about ‘scammy’ advertisers and the bad user experience they create. I agree with him and others that some of these offers misrepresent and hurt our industry.

Later in the post he also says:

A big part of the debate about the lead gen scams plaguing Facebook and MySpace via social games is over how much money is being made on these “offers.” Zynga, by far the most successful at building and monetizing these games, is now telling us exactly how much – 1/3 of total revenues, according to Andrew Trader, a co-founder of Zynga:

Andrew Trader, co-founder of Zynga, said the company makes about a third of its revenue from advertising and another third from virtual goods transactions. The last third comes from companies that provide commercial offers, trading Netflix memberships and marketing surveys for in-game cash.

Zynga revenue guesses range all over the place, but are likely $250 million a year or more. That means $80+ million/year is being brought in from legitimate offers like Netflix subscriptions, as well as the really smelly stuff like recurring mobile phone and learning CD subscriptions that trick users into paying big dollars for little or no return value.

What percentage of offer revenue is scammy? We believe it varies over time, and is heading in the wrong direction. Legitimate advertisers like Netflix and Blockbuster, hit with countless laundered subscriptions from repeat subscripers, are said to be dramatically lowering bounty fees paid on signup. Far less scrupulous advertisers like Video Professor and Tatto take their place.

So much for the first generation of big Facebook/MySpace social application startups. Slide and RockYou both got huge valuations in venture rounds. But a new generation of application developers has taken center stage and are racking up big revenues and their own eye popping valuations: Zynga, Playfish and Playdom.

All three own popular social games on Facebook and MySpace. Zynga’s Farmville has 61 million monthly users. Playfish’s Pet Society has 21 million monthly users on Facebook. And Playdom has 16+ million monthly users of Mobsters on MySpace and Facebook Combined.

All three companies are getting a ton of press and investor attention. Zynga wants to go public next year. Playfish probably already got bought by EA for $400 million or more. And Playdom probably raised an unannounced big chunk of venture capital over the summer.

These three companies may be generating as much as $300 million annually on sales of virtual goods. Need a shotgun to do that next job on Mobsters? No problem. Pay with a credit card, paypal, or your mobile phone and it’s all yours. And people are obviously very willing to buy these virtual goods. Nothing new there.

The goal of all of these games is to get to a higher level, and generally have more fun growing things or killing things faster than your friends. Get addicted to the free version, then start spending to move things along more quickly. Once people are committed, it’s easy to get them to pay. You can read all about it on Business Week.

Except Business Week didn’t mention the dark side of the business at all.

Social gaming startup Zynga is seeing some impressive traction. It now boats 129 million monthly active users across its portfolio of more than 30 games, according to both Inside Facebook’s AppData(see chart) and Developer Analytics. That’s up from about 50 million three months ago, and 30 million in April.

Zynga’s most popular games are FarmVille (the most popular game on Facebook with 50 million cumulative players), Mafia Wars (the second most popular game on Facebook with 25 million), Zynga Poker, and YoVille. The majority of Zynga’s users play its games on Facebook, but it also has games Bebo, Hi5, MySapce, and Friendster.

Here’s the thing I love about Reid Hoffman. There’s no “We-don’t-comment-on-rumors-and-speculation” BS with him. You ask him a question and he gives you an answer.

So you don’t need a bunch of words from me, just go to the jump and watch our final backstage interview of the conference where Hoffman talks about whether LinkedIn will buy Xing and whether it’ll file to go public this year.

Also, Hoffman names the three other tech companies he thinks can price pretty much whenever they want. (And lucky him, he’s an investor in two.)

Social game startup Zynga sure does get into a lot of legal fights. Just as they settle down to business with the Playdom you-stole-our-playbook fight, we’ve confirmed that they settled a different lawsuit – one where they were playing defense.

In February 2009 Mob Wars creator David Maestri sued Zynga for copyright infringement. Maestri himself had only recently cleared up his own rights to the game after a scuffle with his former employer, SGN.

The Maestri-Zynga lawsuit has now been settled as well. The rumor was that Maestri was demanding $10 million from Zynga to settle the litigation. Ultimately, says one source, he got a payment in the “high seven figures.” So that implies something like $7 – $9 million.

It’s a day late, but social game site (and Zynga-antagonizer) Playdom has finally responded to our request for comment on the lawsuit and temporary restraining order they got hit with earlier this week (all the legal documents are here).

The statement, emailed to us earlier today, is short and sweet and contains very little information at all:

This lawsuit comes as no surprise given Zynga’s penchant for litigation. We do not believe in using unnecessary litigation as a business strategy, and we are troubled to see an industry as bright and promising as ours weighed down by such tactics.

We have no interest in Zynga’s “Playbook” or “secret sauce.” Our strength comes from our 111 talented people, and we will defend ourselves vigorously against this distraction.

The lawsuit stems from seven former-Zynga, now-Playdom employees who may or may not have taken a few proprietary documents with them to their new jobs. Among the documents Playdom is accused of stealing is the fast-becoming-legendary/mythical “Zynga Playbook”: “The Zynga Playbook is literally the recipe book that contains Zynga’s “secret sauce,” and its contents would be invaluable to a competitor like Playdom,” says Zynga in the lawsuit.

This is an update to our post earlier today on the Zynga/Playdom trade secrets litigation.

Below are the three documents relevant to the case. The first below is the original complaint that outlines the entire lawsuit. The second is a memorandum authored by Zynga supporting their request for a temporary restraining order, the third is the order granting Zynga a temporary restraining order against Playdom and the other defendants.

The documents are below:

There’s no love lost between competing social gaming platforms Zynga and Playdom. Earlier this year Zynga sued Playdom over what they called misleading ads. That litigation appears to remain outstanding, but Playdom has since changed their advertising practices.

Now there’s a much more serious dispute between the companies. Yesterday Zynga filed a lawsuit against Playdom and a number of other defendants in California state court. Among the many causes of action: misappropriation of trade secrets, breach of contract, breach of the duty of loyalty, tortious interference with contracts, tortious interference with existing and prospective economic advantage and unfair competition. The defendants include four ex-Zynga, now Playdom employees as well.

What this boils down to: Playdom has allegedly hired away a number of Zynga employees, and those employees have allegedly taken key information and documents from Zynga and have given them to Playdom. Among the most important documents that were supposedly stolen: The Zynga Playbook:

Something dramatic is going on between Zynga CEO Mark Pincus and one of his old employees at Tribe.net, a company he cofounded in 2003. Pincus has obtained a temporary restraining order on Darren McKeeman, formerly the IT Director at Tribe. Cisco acquired the company in 2007.

Pinkus hasn’t returned a request for comment, but the TRO was filed in the Superior Court of California, County of San Francisco.

McKeeman is prohibited from contacting Pincus at all, and must stay at least 50 yards away from him. He is also explicitly prohibited from any of the following to Pincus: “harass, attack, strike, threaten, assault (sexually or otherwise), hit, follow, stalk, destroy personal property, keep under surveillance or block movements.” He is also restricted from purchasing guns or other firearms, and must sell or turn in any guns that he owns.

A few weeks ago a good source gave me a legal document written by a former federal prosecutor and senior Department of Justice official. It was arguing that social gaming company Zynga could be breaking multiple state and federal anti-gambling laws via its popular Texas HoldEm game.

A few things are striking about this. First off, Zynga is one a handful of companies building Facebook and iPhone apps that has found a way to make money. Lots of money. Close to $200 hundred million in revenues to be precise. The fact that it could be the next target for an overzealous state attorney is a big story in and of itself. Second, the fact that competitors are this threatened by Zynga’s cash machine shows an ugly battle royale brewing in the application space. (More on that in a bit.)

Online gambling is illegal, according to the U.S. State Department and a handful of states, but there are still some gray areas. In June, the Feds started cracking down on gamblers in an attempt to clear things up. Meanwhile, others like Massachusetts representative Barney Frank are seeking to legalize and tax the $1 billion or more in annual revenues U.S. poker players are mostly sending to sites based overseas. Frank clearly faces a huge uphill battle from religious groups who see poker as a moral issue.

But a site like Zynga should be able to side-step all of this, because although you can buy chips for Zynga’s Texas HoldEm game you can’t redeem them for money, right? Maybe not.

When I wrote my BusinessWeek column on Zygna a while back, every venture capitalist in the Valley told me that Playdom was the company’s biggest competitor.

After all, it competes game-to-game, with similar mob-style and poker games, and was said to be doing the same revenues as Zynga with much higher profitability. (As my column pointed out, Zynga’s revenues are more like double Playdom’s—and since I’ve heard the discrepancy is even greater.)

As you’d expect Zynga’s CEO Mark Pincus pooh-poohed Playdom as any sort of threat. But tellingly, he said the company he was worried about was UK-based Playfish. So, while I was across the pond, I decided to see what the fuss was about and sat down with Playfish’s founder and CEO Kristian Segerstrale. I came away convinced this was one of the hottest companies to watch in the UK. Here are five reasons why.

Playdom, a popular social gaming developer on MySpace, is moving to a studio model, similar to the model of competitor Zynga. Playdom has largely flown under our radar until now, but they’ve built up some very popular social networking apps on MySpace, and are also moving to Facebook as well.

Adopting the studio model means that Playdom will have multiple independent teams working on different games. To head up the two studios, Playdom has brought in substantial talent from successful gaming companies. Former Director of Game Design at Zynga, Dave Rohrl, will oversee a studio focused on new intellectual property and former Studio Director at Pogoa/Electronic Arts, Sean Clark will head a studio focused on role-playing games or RPGs.

Yandex Labs CEO Vish Makhijani, a former Yahoo executive, will be leaving his operational role at the company, we’ve learned, and will be taking a new “senior operating role” at fast growing Zynga. He’ll start at Zynga in June and will join the Yandex board of directors.

Makhijani joined Yandex, the largest Russian search engine, in June 2008, less than a year ago, to create Yandex Labs. The labs group is a Silicon Valley based tech and business development project with ten or so employees. Arkady Borkovsky, currently CTO of Yandex Labs, will be taking over the group.

It’s a little unusual that Makhijani would leave Yandex so soon after joining, given how well the company is doing. They filed to go public late last year on 2008 revenues of more than $300 million, but later pulled the registration statement. The company has 1,700 employees.

But Makhijani says he’ll continue to work with Yandex at the board level, and has accomplished much of what he set out to do with Yandex Labs. And he’s exciting about working with Zynga, which is clearly on IPO or big buyout track itself with annual revenue in the $100 million range.

Prior to Yandex Makhijani was SVP and General Manager of the Yahoo Search Group. He left amid the general chaos at Yahoo last year.