U.S. Circuit Judge Stephanos Bibas ruled on Wednesday there was no securities fraud in a case that turned on NASCAR Heat 5, a video game that simulated the 2020 NASCAR season, exceeding sales expectations. The ruling could set key precedent in securities fraud litigation, including for securities in the sports and video game industries.
Four years ago, Innovate, a publicly traded company that owns other companies, brought (through Innovate 2 Corp.) a securities fraud suit against Motorsport Games. Motorsport owns a majority of 704Games, a video game developer that has an exclusive license to make NASCAR video games. The case concerns a board meeting held in June 2020 when 704Games officials offered a pessimistic sales outlook for NASCAR Heat 5, which was set to publish a month later.
Innovate owned a majority of 704Games until 2018; after years of not turning a profit, Innovate sold its majority stake to Motorsport, with Innovate retaining 13.5% ownership. A year later, Innovate and other minority shareholders tried to sell their 704Games shares to Motorsport, but Motorsport wouldn’t pay the demanded price.
During the June 2020 board meeting, 704Games offered a gloomy picture for NASCAR Heat 5. It was a portrayal that, Innovate charges, was intentionally exaggerated for purposes of misleading minority shareholders. Innovate believes 704Games wanted to convince it and other minority shareholders to dump their shares at a low price before Motorsport would go public (Motorsport had an IPO in January 2021 and is traded on NASDAQ as MSGM).
The board meeting featured a slideshow that indicated pre-sales of NASCAR Heat 5 were very poor, 27% behind NASCAR Heat 4 (the previous game in the series) at the same time in development. The presentation also revealed the gaming community had largely dismissed NASCAR Heat 5 as a “copy/paste” of NASCAR Heat 4, meaning there was concern NASCAR 5 would largely replicate, with only modest updates, NASCAR Heat 4.
At least some of those concerns seemed warranted. NASCAR Heat 5 received mediocre reviews; the PlayStation version earned a Metacritic score of 63 (meaning “mixed” or “average”) and critics bemoaned that the game lacked innovation. Lockdowns from the COVID-19 pandemic were also mentioned in the presentation as reason to expect NASCAR Heat 5 would struggle. Worst yet, 704Games warned it would “run out of money next year . . . even if we hit our current projections.”
The alleged fraud continued after the June board meeting, as Motorsport’s CFO opined to minority investors the company had regrettably overpaid for 704Games by $1.1 million. By August 2020, the minority investors were ready to sell, and Motorsport bought Innovate’s stake for about $620,000.
As Innovate sees it, Motorsport and 704Games scripted the dire outlook while knowing NASCAR Heat 5 would perform better. Innovate points out that about a month after the board meeting, Motorsport’s director of sales told a NASCAR official that the game was selling well, especially with respect to digital sales (where consumers pay to download the game instead of purchasing a physical copy). Innovate and other minority shareholders were allegedly not told this information. Also, while the board meeting featured grave warnings about 704Games’ financial outlook, Motorsport had just received a $10 million line of credit.
Bibas, who presides at the U.S. Court of Appeals for the Third Circuit and is serving as a trial judge by designation for this case in Delaware, reasoned Innovate’s theory doesn’t illustrate securities fraud, instead saying it reflects a company selling its shares in another company “for what, in hindsight, appears to be less than it could have gotten if it had held onto them.” The judge stressed “not every poor investment decision is due to securities fraud.”
Bibas further emphasized that a finding of fraud under the Securities Exchange Act requires multiple elements, but that Innovate failed to establish the first one: misrepresentation or omission of material fact.
He wrote that “Innovate has no evidence that any representations at that meeting were false when made.” To the contrary, Bibas underscored, Motorsport had good reason to worry about financial projections given 704Games’ financial history and given the game wasn’t, it seemed, shaping up as a hit.
“There is nothing showing that Motorsport inadequately considered the available data or used unsound forecasting methods,” Bibas stressed. The judge added that while there are emails and spreadsheets from Motorsport officials in July and August 2020 indicating NASCAR Heat 5 was selling well, that evidence doesn’t show misrepresentation—it only shows the game exceeded expectations.
Bibas also noted that Motorsport had no duty to correct what was said in the June 2020 board meeting. That’s because “Innovate has no evidence” anything said was false at the time it was said.
Likewise, the judge reasoned that Motorsport had no duty to update Innovate. He wrote that while it is “true” the “original projections about Heat 5 sales weren’t borne out,” those projections “were accurate when made.” Bibas also explained there is no automatic duty for companies to provide “continuous” updates. An update would have been warranted, Bibas explained, in the event of a takeover, merger or liquidation, but a game selling better than expected doesn’t rise to that level.
Innovate can appeal Bibas’ decision to grant summary judgment to Motorsport to the Third Circuit.
The major sports leagues in the U.S., along with their respective players’ associations, license the intellectual property of those leagues, teams and athletes for use in video games. Often the games are released on a yearly cycle and the games’ publisher must overcome consumer skepticism that the game will be a “copy/paste” of the prior year’s version. Innovate v. Motorsport Games is an interesting and useful decision for publishers and developers as they raise capital from investors for sports video games.
