Take-Two served by DA, slammed by investors

[UPDATE] Hot Coffee continues to percolate as lead Manhattan prosecutor announces investigation over hidden sex-game controversy; analyst cools to Take-Two shares as stock drops to new 52-week low.

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In the summer of 2005, game-industry news exploded over the so-called "Hot Coffee" controversy. The flap erupted over the fact that Grand Theft Auto: San Andreas--which has sold more than 7.2 million copies as of May 2005, according to industry-research group NPD Funworld--contained a hidden sex scene unlockable with a third-party mod or cheat device. The rerating came because the game was found to contain mingames that featured clothed representations of adults engaging in consensual activity.

As a result, the Entertainment Software Ratings Board rerated San Andreas from M for Mature to AO for Adults Only--giving it the retail equivalent of a hemlock smoothie. The game was pulled from retailers, which enforce a self-imposed ban on AO-rated titles, and wasn't available again at retail until fall 2005, when an edited version was released for the PlayStation 2, Xbox, and PC.

Not quite a year later, the New York county district attorney has deemed the now-budget-priced game worthy of further investigation. A week ago, Take-Two was served by a grand jury that has launched an investigation into the publisher and its subsidiary, Rockstar Games, dating back five years.

In a terse statement, the company asserted, "Take-Two Interactive Software, Inc. today announced that on June 19, 2006, the Company received grand jury subpoenas issued by the District Attorney of the County of New York requesting production of documents, covering various periods beginning on October 1, 2001, including those relating to: the knowledge of the Company's officers and directors regarding the creation, inclusion and programming of hidden scenes (commonly referred to as 'Hot Coffee') in Grand Theft Auto: San Andreas."

[UPDATE] One financial analyst, spooked by the potential of upcoming criminal indictments being served on company officials, said this morning he would "avoid the company's shares until the criminal investigation is concluded." Acknowledging that "the criminal nature of this investigation is likely to scare all but the most risk-tolerant investors," Michael Pachter of Wedbush Morgan said he was maintaining a Hold rating, but suspending any price target for the stock.

Commenting on a Securities and Exchange Commission investigation which began in 2002 and was resolved in 2005, as well as a the recently resolved Federal Trade Commission investigation into the "Hot Coffee" mod, Pachter said that due to the criminal nature of the current investigation, the future for Take Two is uncertain.

"The subpoenas leave us baffled, and raise the specter of quite serious consequences," Pachter said today in a memo to investors. "The potential outcomes range from indictments and convictions of key employees to no indictments issued at all. Should one or more key strategic, operating or creative employee be charged with criminal activity, we believe that at a minimum, the employee charged would be distracted from performing his or her duties for the company, and at a maximum, the employee charged would be convicted and would likely leave the company."

Pachter also added his two cents when it came to the potential far-reaching impact of the investigation. "We believe that other parties may have also received subpoenas, as it is customary for a criminal investigation to include all parties involved in the alleged criminal activity. Although we are in no position to know what the grand jury hopes to accomplish, we think it is likely that current and former Take-Two employees and directors will be asked to testify in the future."

At press time on Tuesday, Take-Two shares were off 15 percent, down $1.93 to $10.93. That price establishes a new 52-week low for TTWO shares. [END UPDATE]

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