Assuming the new site does well, we can likely expect Zynga to port its other games to their own standalone portals down the line.

Zynga has recently been in the headlines lately over our reporting on its use of scammy offers to help monetize its games (other social gaming companies are guilty of the same practice). Zynga removed those scams promptly, but then they reappeared. Finally Zynga announced they were gone for good, but that isn’t the end of the story: now there’s a class action lawsuit against Zynga and many other companies who allegedly engaged in these scams.

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It’s ScamVille, the lawsuit. And we’ve spoken to one other law firm considering a class action claim against these companies.

Will users be vindicated and get their money back? Maybe part of it. A recent class action settlement against WebLoyalty for post transaction marketing scams led to a $10 million settlement, just a tiny fraction of the total revenue pulled in by these offers. The law firms are the ones who get a payday.

Gawker, which broke the story, makes a good point though. That video of Pincus looks bad enough on a blog. Imagine what a jury will think of it. And services like Offerpal have now admitted that what they did was questionable. This will likely settle quickly.

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And today we’ve confirmed that another one, Playdom, has done its own massive deal: $43 million on a $260 million pre-money valuation. New Enterprise Associates, Rick Thompson, Lightspeed Venture Partners and Norwest Venture Partners invested in the round.

This is Playdom’s first outside round of funding.

Unlike Zynga and Playfish, who focus on Facebook, Playdom’s is the big player on MySpace. Their Mob Wars game has 14 million or so users there, and the company is likely pulling in $60 million or more in reveune. A couple of weeks ago we compared the big three social gaming companies as a prelude to our Scamville posts.

Playdom has 28 million monthly game users. 60% of traffic is from MySpace v. 40% from Facebook. They have twelve MySpace apps and 6 Facebook Apps.

Playdom is enemy no. 1 to Zynga, and has been accused by Zynga of stealing employees and the company’s intellectual property. Of course, no one’s hands are clean in this business.

70% of Playdom’s revenue comes from direct payments, the company says, 10% is advertising and 20% is offers. For offers, they work with usual suspects. But they have banned the spammier stuff, like mobile subscriptions.

One thing’s for sure. Zynga has more users of its games than Playfish and Playdom combined, and they tend to monetize far better, too (at least until last weekend). It’s not unreasonable to imply a $1 billion valuation to Zynga based on these comps. They’ll be looking to the public markets, though, for their exit.

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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.

Hey everyone,

Good news! Issues have been resolved and FishVille will be back online tonight at approximately 12:00am PST. We have been feeding your fish to keep them happy and growing during the downtime, so they should be just fine when you return to your tanks. Thank you all so much for your patience and understanding.

-Team FishVille

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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:

Ensuring zynga’s user experience – removing all cpa offers

michael arrington posted yesterday on mobile offerings still being shown in our new game fishville. I want to explain why this occurred and how we are taking more aggressive steps to ensure this never happens again.

zynga has not been able to control the ad content as it is managed by the offer companies that we work with.

with regards to yesterday’s incident, the offer provider, doubleding, told us this was the result of their failure to remove an optimization queue which was still showing these ads to 10% of pageviews. i want to be clear that zynga had no control over the pages being shown and never filtered them from michael or anyone’s view.

we recognize it is our responsibility to ensure that offers which generate a bad user experience are not shown with any of our games.

therefore, we are removing all CPA offers across zynga games until we can control their inclusion and presentation ourselves. This will be effective by end of day today. this move is worth it for the long-term user experience and value to our partners like facebook and myspace.

yesterday’s mobile offer issue was particularly painful as we had helped fund doubleding earlier this year in the hopes of cleaning up the space and raising the bar on user experience. we intend to influence them and others to improve their ad content and be long-term focused for the success of the social gaming and social networking industries.

as I said in my post last monday, my mission is to build zynga into a sustainable consumer service with enduring value to our users. we will continue to do whatever it takes to earn our users trust and respect for the long-term.

We’ve also heard from DoubleDing President Matt Handal, who responds to our article yesterday:

Michael,

I am the President of DoubleDing and this is not the way I wanted to meet you. I wanted to provide you with some additional information and offer more details for your Zynga article dated Nov. 6. It is my desire that you relay this information to your readers as soon as possible.

It is our intention to fully comply with all Facebook, as well as partner (e.g. Zynga), advertising standards. Zynga’s standards require us to remove all mobile offers which do not offer a clear user value. We take 100% responsibility for any issues that arise from our actions and commit to correcting any errors.

As evident from our logo on the bottom of the offer wall, DoubleDing powers the offerwall displayed in this article. Mobile offers were displayed because of a technical glitch in our system. We have an optimization engine that serves advertisements to 10% of the traffic. Sometime late Thursday or early Friday, a bug in this engine began pulling previously removed mobile offers and displayed them in the mobile tab of our wall. If a user would have refreshed the page 10 times, they would have seen offers in the mobile tab only once. We identified the bug and corrected this within 30 minutes of being notified today. There was NO IP BLOCKING of any sort, beyond the normal country and fraud blocking.

Finally, to reiterate our commitment and seriousness of our intent to adhere to high standards and bring value to the growing virtual currency space, we will be donating ALL revenues derived from this and any future mistakes of this sort to charity. DoubleDing will NOT derive any financial benefit from any such issues.

If you would like any more information or to discuss further, please feel free to contact me directly.

Thanks,

Matt Handal
President
www.DoubleDing.com

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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.

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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:

Is Zynga intentionally blocking ads to journalists and bloggers that have criticized them for the practice, while leaving them up for everyone else? More on that in a minute.

The ads, which have now been removed after I emailed Zynga, are exactly the same as before, and they are the main reason I started the whole series of posts on social games – see our ScamVille post and related updates.

These ads clearly violate Facebook’s terms and conditions. They don’t state on the offer page that the user is required to enter into a $10 – $20/month mobile subscription, and there is no opt in by the user before entering in personal information. And they also violate the rules in other minor ways, like having auto-playing video and audio in the ads.

There’s an image at the bottom of the post showing just the mobile offers that were up on Zynga’s games until earlier today when we asked them about this. All of these violate Facebook’s existing terms, and any normal human being would consider them scams. And none of these should be there given Zynga’s promise to take down all mobile offers.

Since most people have never experienced one of these ads to understand just what we’re talking about, I made a video. After ten minutes I had been asked to subscribe to 5 or 6 separate mobile subscriptions, had been asked for my birthday, and had been asked to enter in my email address. Even after all that I hadn’t earned the originally promised coins, and abandoned the effort (getting users to abandon these offers part way through is its own business model, referred to as “breakage”). Here’s the video:

What’s disheartening to me isn’t that Zynga put the mobile ads back up, or even that appear to have selectively blocked me so that I don’t personally see the ads. Their motivations are quite clear. What’s really disappointing is that Facebook, even after promising to enforce their rules, continues to just turn a blind eye to this stuff. I know Facebook hates the negative press, but I am really starting to think that they couldn’t care less about their users getting scammed.

In the last few days the industry really started to make the right moves and I thought this was a problem that would soon be solved. But then I realized that as much users hate being scammed, and as much as the press is willing to put the pressure on (both Time and Newsweek are pointing the finger at Facebook), there may just be too much money at stake for any meaningful self regulation to occur.

We await official comments from Zynga and Facebook.

Update: From Zynga “We asked all offer provider networks to remove the mobile category. Upon learning today that one provider was still showing 6 ads, we asked them to remove these too. They told us they hadn’t realized this was still in their testing queue and immediately removed them.”

Update 2: DoubleDing, the offer provider in this case, responds to this post and denies any filtering of ads. Full email from the DoubleDing President is here.

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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.

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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:

Subject: RockYou Offers: Facebook Offer Wall Compliance Update

Hi RockYou Publishers,

You may have heard the recent controversy around the types of offers that are being run by most offer wall providers (Offerpal, SuperRewards, etc.). If you haven’t heard, take a look at this post on TechCrunch:
http://www.techcrunch.com/2009/10/31/scamville-the-social-gaming-ecosystem-of-hell/

The Facebook compliance team will be keeping a very close eye on offer walls starting tonight.

Since the RockYou Ad Network is the largest display network on the Facebook platform, we have a long history of working directly with the Facebook compliance team to ensure that we always maintain the highest standards of compliance and ad quality.

We will apply the same level of quality assurance to our RockYou Offers platform.

Some thing to keep in mind that set us apart from the other offer wall providers:
* 100% Facebook compliance starting this evening, and on an ongoing basis
* Clean, safe surveys from top tier brand advertisers
* High quality brand campaigns ranging from video ads to free sample offers
* Cost-per-install campaigns for other Facebook applications

We believe we will continue to outperform the competition based on our diverse advertiser base, and we will do so while always maintaining full compliance with Facebook policy.

Our technology provider for RockYou Offers, PeanutLabs, has also posted an interesting research study they ran over the weekend that clearly outlines how users feel about the scammy offers that have been so prevalent on offer walls:
http://peanutlabs.wordpress.com/2009/11/02/survey-finds-arrington-has-a-point-given-choice-users-overwhelmingly-prefer-direct-payments-and-research-surveys-to-cpa-offers/

We believe the new Facebook policy enforcement is in the best interest of Facebook users and the entire platform ecosystem, and we look forward to working with you as a safe and effective monetization partner.

If you have not yet switched over to RockYou Offers, all you have to do is:
1. Log in to your publisher account at ads.rockyou.com
2. Click on the RockYou Offers tab
3. Follow the 4-step integration process

If you have any questions or issues with integration, please contact Chris or Aaron:

Chris Akhavan
[redacted]

Aaron Choi
[redacted]

Thank you,
RockYou Offers Team

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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:

We have worked hard to police and remove bad offers. In fact, the worst offender, tatto media, referenced in the techcrunch article, had already been taken down and permanently banned prior to the post. Nevertheless, 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. We have also removed all mobile ads until we see any that offer clear user value.

At zynga, we have faced a similar challenge in providing customer support to millions of users of our free games. Six months ago we were overwhelmed with our ticket volumes and faced an F rating with the better business bureau. We made massive efforts to address this, getting our maximum response times for live email and phone support down to 72 hours and raised our rating to a B+. Even today we realize our customer support isn’t at the level our users expect and we continue to work on it.

Hats off to Zynga. Flat out admitting that the problem exists and taking early steps to fix it is just something you don’t see from most companies. While Offerpal’s CEO (why coincidentally and humorously has 666 Facebook friends) takes an offensive “shit, doubleshit and bullshit” denial strategy, Zynga’s CEO just stepped up to the plate and hit the ball out of the park. He also just self regulated before Facebook or MySpace could even respond.

There may be hope yet for the Internet.

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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.

HotOrNot cofounder James Hong said it best in a comment to our post yesterday outlining the scams: “In a nutshell, the offers that monetize the best are the ones that scam/trick users. Sure we had netflix ads show up, and clearly those do convert to some degree, but i’m pretty sure most of the money ended up getting our users hooked into auto-recurring SMS subscriptions for horoscopes and stuff.”

Offerpal and others, who provide these offers to game developers, try to downplay the percentage of revenue that comes from scams. Clearly they are obfuscating the truth, to put it kindly.

Facebook and MySpace must takes steps to address this.

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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.

All three companies are willing to give game currency in exchange for offers. Sign up for Netflix. Buy a ringtone subscription. Or energy drinks. Sign up for a credit card. Get car insurance. Take an IQ survey that requires a $9.99/month mobile subscription to see the results. We even found one for arthritis medication. Here’s how it all looks. One executive we spoke with says that 70% of total revenue from these applications may come in from lead generation, not direct payments. Netflix alone will pay $30-$40 for a free trial (requires credit card).

Three companies control most of these lead generation offers: TrialPay (appears to have the most legitimate offers), Offerpal and SuperRewards.

There’s nothing wrong with basing a business off of lead generation, although some of the offers are pretty sketchy (long term credit card or mobile subscriptions for little or no value). And the FTC does tend to take a swipe at them periodically. But the bigger problem is that advertisers may not be getting much for their payouts. As the higher quality advertisers bail, pressure to add the scam artists increases.

The cycle of all of these games is pretty standard. Get new users playing for free, give them incentives to message all their friends to signup, hit them hard for cash or lead generation for revenue, and move them up the levels. Rinse. Repeat.

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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.

Heere are some fun stats about each of its top games:

FarmVille—sort of like a Sim Farm, where you grow your own crops and manage a farm, FarmVille users have built more than 40 million virtual farms (which is 20 times more than actually exist in the U.S.). Players buy 500,000 virtual tractors a day in the game.

Mafia Wars —Every month, 140 million “jobs” are done by aspiring cappos in this game.

Zynga Poker—This used to be calledd Texas Hold’Em. Every day about 150 million hands are dealt (more than ten times as many as are dealt on an averag day in Las Vegas), and on there are usually 250,000 concurrent players, so you can always find a game.

YoVille—A game where you furnish a virtual apartment, buy pets, and eat funnel cakes. The 17 million residnents of YoVille have bought 10,000 pets and 40,000 funnel cakes since August alone.

As Zynga continues to grow, so does the IPO talk (and the litigation). Its revenues, which is well above nine figures now, possibly as high as $200 million a year, comes largely from its virtual currency, as well as ads.

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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.)

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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.

Wonder why the settlement was so high? It’s hard to believe, but Mob Wars was pulling in an estimated $1 million/month at one point from users eager to upgrade their weapons and other stuff. These games seem silly, but real money flows through them from virtual goods.

Not a bad payday for Maestri. And it also highlights the fact that none of these companies have a completely clean record when it comes to respecting the intellectual property of competitors.

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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.

Did Playdom steal it? All they say is they have “no interest” in the document. It seems to me that the only way they could know that for sure is if they’ve read it. I mean, if the New York Times had a playbook, I sure would be interested in it. Unless I’d read it and found it uninteresting, that is. So I’ll ask again, Playdom. Did you steal the Zynga Playbook?

And if you did, can I have a copy?

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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:

Zynga’s Complaint –

MPA for EX Part App –

Order Granting EX Parte App –

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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:

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. The Zynga Playbook constitutes a collection in one document of many of the most material non-public commercially valuable concepts, techniques, know-how and best practices for developing successful and distinctive social games. The Playbook is the result of years of testing, development, trial and error, analyzing customer behavior, game behavior, optimizing past successful techniques, and collective know-how that Zynga has spent millions of dollars and more than tens of thousands of man hours developing and devising, and which could only be compiled by developing and deploying successful games over a period of years to millions of them. In the hands of a competitor like Playdom, this document alone creates huge exposure to Zynga as it breaks down in detail and memorializes the company’s key and collective efforts to develop and fit games to the social networking platform in the most successful manner. It is a “how-to” manual that belongs to Zynga.

Zynga accuses Playdom of actively soliciting Zynga employees to turn over proprietary information:

…Playdom recruiter Jennifer Farris emailed Defendant Martha Sapeta, a then-current Zynga employee who owed her undivided loyalty and best efforts to Zynga, with a “small assignment” as part of an upcoming and lengthy recruiting and interview meeting. Playdom instructed Defendant Sapeta to “compare and contrast” the precise Zynga games she was working on to corresponding competing Playdom games. Sapeta was offered “bonus points” if she could “propose a feature in [Playdom's competing] game that [she][thought] whould improve [user] growth.” Playdom even suggested the feature “can be a straight up ripoff from our competitors [i.e., Zynga's] app,” but with the caveat that Sapeta would “still have to explain in detail” how the ripped off features would work in Playdom’s competing game.

Specifically, Zynga accuses an ex-employee of downloading 70 files to a USB storage device two weeks before leaving to join Playdom. Three of the files were proprietary Zynga documents. Another defendant mailed 22 proprietary documents to his personal email account before departing to Playdom. The Zynga Playbook was among them.

The judge granted the request for a temporary restraining order against Playdom and the other defendants. Those defendants are prohibited from destroying any of the files allegedly misappropriated.

Neither company would comment on this story.

Update: The relevant court documents are here.

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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.

Pincus 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.

McKeeman’s only response so far: “Note to everyone: don’t lie in things you file in court! It will come back to haunt you! I’m quite happy these morons did lie, though.”

Someone pass the popcorn.

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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 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.

According to the brief, the issue boils down to three factors:

The answers to the first two are pretty clear—and not contested by Zynga. Poker is clearly considered gambling in the offline world, and poker specifically has been proven in New York State court to be a game of chance not skill in the case of New York v. Turner. That decision read: “Games of chance range from those that require no skill, such as a lottery…to those such as poker, blackjack which require considerable skill in calculating the probability of drawing particular cards. Nonetheless, the latter are as much games of chance as the former, since the outcome depends to a material degree upon the random distribution of cards.”

The third question is where things get murky. Zynga liberally gives people free chips every time they log in. But you can also buy chips. That constitutes the user betting something of value. So what about the outcome? Do users win something of value?

A prosecutor could argue a few angles here: Within the game, there’s the case that the chips are of value because they can be used to buy virtual gifts for others or that extended game play and privileges given to players who win more chips constitutes something of value. There’s some precedent under New York State law (specifically entailing poker machines in Plato’s Cave Corporation v. State Liquor Authority) showing that continued play constitutes something of value. But Zynga could easily argue that there are so many opportunities for continued free play and so many free chips given away at every log in that players clearly aren’t motivated to win because of material gains.

The one place where Zynga chips do have a clear material value is on illegal secondary markets where chips are regularly bought and sold, and because Zynga allows Facebook friends to send chips to each other transferring chips to a black-market buyer isn’t hard. (Zynga only allows you to gift 100 chips per day, so it is time-consuming.) The brief argues that these illegal markets are readily found with a Google search and that “While Zynga does not support the black market, an argument could be made that they profit from it and do so knowingly.”

Zynga takes issue with that and argues that it has gone to great lengths to squash the secondary market for chips and enforce its Terms of Service. Zynga has filed numerous cease and desist letters to sites and ISPs, has taken down sites by enforcing legal protections surrounding its own copyrights and trademarks, daily monitors the Web looking for these illegitimate sites, worked with payment processors like PayPal to accelerate the take down of these sites and filed numerous legal actions.

There’s a demonstrable paper trail showing Zynga’s efforts to clamp down on these secondary markets. Cases have included: Zynga Game Network, Inc. v. Phillip Labrasca / Complaint Filed July 1, 2009, Zynga Game Network, Inc. v. Duc Doan /  Complaint Filed July 1, 2009, Zynga Game Network, Inc. v. Carmi Solak / Complaint Filed July 14, 2009, Zynga Game Network, Inc. v. Jason McCann / Complaint Filed: July 14, 2009, Zynga Game Network, Inc. v. Chris Sim II / Complaint Filed July 14, 2009 and Zynga Game Network, Inc. v. Moss Brothers / Complaint Filed July 14, 2009.

This all raises the question: Why doesn’t  Zynga just turn-off the ability to gift friends chips? I expect if prosecutors started to seriously circle, the company would shut it down.

It’s hardly a slam dunk that Zynga is breaking the law and a stretch to say going after them is in the public’s interest. The Feds certainly have much more explicit examples of online gambling to focus on first. But could I see an over-zealous legislator or state attorney general bringing a case against them for political reasons? Absolutely. These are people who believe that online dating sites lead to rape, MySpace leads to pedophilia and Twitter leads to terrorism. Crazier claims have certainly been made than saying a game called “poker” could be encouraging online gambling. And while you can argue that World of Warcraft, Second Life or any game operating in the virtual goods economy has the same issues, a game called poker would likely be a clearer target.

Now, back to the competitor who leaked us the brief. The person called the meeting under the condition of anonymity, so I can’t divulge who it was. But the source argued they commissioned the brief because they too had thought of building poker applications, having watched Zynga’s success and wanted to see if there would be legal implications down the line. The findings were enough to scare them away from it. The competitor then decided to leak it because it thought it was unfair that Zynga was using potentially illegal revenues to its own competitive advantage in other applications like Mafia Wars. The competitor alleged that Zynga spends some $500,000 a week on Facebook ads and another $2 million to $3 million per month on MySpace advertising.

Whether you find the leak a savvy or slimy business move, it was certainly ballsy: If Zynga is called out it will have a chilling effect on the entire virtual goods space which appears to be one of the most lucrative business models going on the Web.

Lastly, I was disappointed that Zynga chief executive Mark Pincus refused to address the claims on the record. I have a huge amount of respect for Pincus and as such gave him every opportunity, including sharing the brief itself nearly a week before publication of this post. The brief raises legitimate questions and if Zynga really believes its operating in the clear, why not just say so on the record?

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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.

1. Not “The UK Zynga.” Playfish is very much running its own race in this market, and this may be a case where distance from the Valley is actually healthy. It doesn’t try to compete on specific games with Playdom, SGN, and Zynga. For instance, it doesn’t have a mob game, the most popular genre right now, and it doesn’t have a poker game, Zynga’s top earner. “That’s such short term thinking,” Segerstrale said. “Something is wrong if your route to success is copying competitors’ games.”

2. Platform Development Doesn’t Have to Mean Half-Ass Development. Playfish is not about building a game in a week or so and throwing it up on Facebook. Playfish spends six months to a year designing a game, and they’ve only produced seven of them. While everyone else talks up how quickly and cheaply you can build a game on social networks, Playfish still employs the same artistic discipline of a console game with a Wii-like look and feel. The plus with platforms like Facebook and the iPhone isn’t speed to market for Playfish, it’s easier distribution and greater social engagement.

3. Traction. The painstaking design process appears to be a hit. Every one of Playfish’s games has been a top ten hit on Facebook. Across all platforms, those seven games have yielded 100 million installs and 30 million monthly uniques, says Segerstrale. Playfish pays “practically nothing” for customer acquisition and makes money through virtual goods, ads and premium versions of games.

Playfish is profitable and hasn’t spent a dime of its recent $17 million funding round. That’s gotta be some top line given Playfish has 200 employees across several offices. In fact, TechCrunch Europe’s Mike Butcher speculated that Playfish could be the $1 million-dollar-a-month Facebook app maker, back in September 2008. It certainly puts the company in an enviable position given the paucity of venture funds in the UK.

4. Proximity to the Valley Insiders via Investors. While Playfish enjoys distance from the one-ups-man-ship or developer poaching of SGN, Playdom and Zynga, it’s connected into the Valley where it counts. One of its main investors is Accel—also one of the main backers of Facebook. Yes, that matters. (See Sequoia Capital-backed Google’s purchase of Sequoia Capital-backed YouTube.)

5. Segerstrale Knows Games. This is the fuzziest one, but also probably the most important. As a CEO, Segerstrale comes to this industry from a different point of view than Pincus. Pincus has said he was never really much of a gamer—Segerstrale on the other hand has loved games since he was three years old playing Pong with his older brother. He always got a visceral rush from playing, especially with other people. So he’s spent much of his career working towards two goals: Decoding what makes a game “fun” and deconstructing the concept of a “gamer” so games are just something everyone plays.

His first attempt was at mobile, thinking that with phones in every pocket, everyone would essentially have a game console. Indeed, the company he cofounded, Glu Mobile, went on to a successful IPO. But gaming was still a niche activity on phones.  There were too many barriers set up by the telcos and it wasn’t as easy for people to find and download games. Facebook turned out to be a much greater platform for this kind of democratization of gaming because users could market games to one another.

Segerstrale’s macro theory is that we’re in the first shift of a move from physical games and goods to digital ones, and from games as a product to games as a service. It’s a theory that seems right-on to me. For one thing, we already saw it with the transition from enterprise software to software as a service. For another, sales of console games are down 20% year-over-year according to NPD, while comScore says social gaming is up 20% year-over-year. It’s nice to see a CEO who can articulate not only a product vision, but a clear industry vision.

All the positives above aside, I’m still not convinced that Segerstrale will succeed in his mission to democratize games. I still mainly use Facebook as a way to connect with friends, not to build virtual restaurants and I don’t necessarily see that changing. In fact, Facebook has so de-emphasized apps in its new all-feed iteration, I spent nearly an hour trying to find a listing of games, before someone finally told me it was on the throw-away bottom bar of the profile page. And by emphasizing the social stickiness of a game, there’s a chicken-and-egg risk that the games are boring for people who don’t have enough friends already playing.

But these are execution risks and every promising startup has them. When it comes to business model, financing, vision and product, Playfish is certainly a formidable competitor to Zynga. With hundreds of millions in real dollars already swarming around social gaming, this will be fun space to watch.

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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.

The Mountain View, Calif.-based company first made a name for itself on MySpace, creating the most popular game on the social network, Mobsters. The startup has 9 of the top 25 games on MySpace. Playdom also made waves on Facebook’s gaming community, creating the popular game Poker Palace.

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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.

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Zynga’s social gaming network is going gangbusters right now, reportedly pushing nine figures in revenue. But the company’s legal woes continue. A former Zynga employee named Robert Fulop has filed suit against the popular social gaming company for violating the Fair Employment and Housing Act (FEHA), the California statute that prevents employee discrimination.

The suit alleges that Zynga has discriminated aginst Fulop on the basis of age and disability, namely those tied to his request to temporarily reduce his work load in the time leading up to and following a heart operation. Fulop is seeking a total of $50,000 in lost compensation and general damages, along with further damages whose amount will be determined at trial. I’ve summarized the suit below and embedded the full document. It’s important to note that the suit obviously paints Zynga in a poor light (the company wouldn’t comment) so keep in mind that it is only one side of the story.

The suit revolves around the termination of Fulop a few months after he began working full time at Zynga, and soon after he informed the company that he would need some time off to undergo a heart procedure. According to the document, Fulop is a long-time game designer with over 30 years in the industry whose career began at Atari in 1979. He was recruited to join Zynga as a contractor from early August 2008 through late September, when he was brought on with Zynga as a full time employee.

A month later he began suffering chest pains (he had a prior heart attack in 2005) and went to the hospital for testing. Fulop notified his team leader that he would need to work from home and part-time for the weeks leading up to and following the operation. Nine days later, Fulop was terminated from that game’s team. According to the document, whether or not he was terminated from the company entirely remained unclear for weeks (he underwent his heart procedure in the mean time). He was terminated from the company soon after the operation.

From the document:

“… As soon as Plantiff informed Zynga of his medical condition and his need for accommodation, he was immediately terminated. Plaintiff’s request for accommodations was summarily ignored without any discussion whatsoever.”
“As a pretext for the termination, Plaintiff was informed that he was being terminated because there was no work for him. This pretext is belied by the fact that Plaintiff was terminated approximately five weeks after he was hired as an employee and by the fact that immediately after Plaintiff was terminated, Zynga sought to hire another person for Plaintiff’s exact position”

This isn’t Zynga’s only legal trouble. In February, the creator of Mob Wars sued the company for copyright infringement (Zynga’s game, Mafia Wars, is very similar).

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So in case it wasn’t already clear, there looks to be a bright future in the online gaming sphere and specifically around micro-transactions. That’s how Zynga makes most of its money. With some of its leading games on MySpace and Facebook, it charges users for playing time or for things like chips in poker. These small purchases which usually amount to only a few dollars at a time, start to add up quick. And that’s only with a small percentage of overall players opting to buy them.

And Zynga recently transitioned this model to the iPhone, but because the iPhone doesn’t yet allow for in-app purchases, it has been forced to sell expensive versions of its apps like Live Poker, with chips included. But that’s about to change with the iPhone 3.0 software due this summer. The new software’s in-app purchases could very well take Zynga’s revenues even higher.

Just last week, VentureBeat’s Eric Eldon speculated that Zynga, which is now the largest Facebook app developer, might be trying to raise another large round of funding — something to the tune of $30 million. Given these revenue numbers — and yes, Zynga is already profitable as well — that certainly doesn’t seem out of the question, but you have to wonder why. The company raised a $29 million round back in July of last year, and has raised $39 million total.

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