The US Securities & Exchange Commission on Monday announced that it has charged Wells Fargo Securities and the state agency formerly known as the Economic Development Corporation with defrauding investors in the municipal bond offering used to finance 38 Studios in Rhode Island.
According to an SEC news release, "The bond offering document produced by the RIEDC and Wells Fargo failed to disclose to investors that 38 Studios had conveyed it needed at least $75 million in funding to produce a particular video game."
"Therefore," the SEC said, "investors weren’t fully informed when deciding to purchase the bonds that 38 Studios faced a funding shortfall even with the loan proceeds and could not develop the video game without additional sources of financing."
Kevin Friedlander, a Wells Fargo spokesman, said in a statement, "Wells Fargo disputes the SEC’s allegations in connection with the placement of these municipal bonds. We will respond to the specific allegations in the complaint in court."
Kayla Rosen, a spokeswoman for the Commerce Corporation, as the EDC was renamed, said in a statement, "The Commerce Corporation is still reviewing today’s filing, which concerns events that occurred under a previous administration. The Commerce Corporation, in its own lawsuit, has alleged that Wells Fargo, Keith Stokes, and Michael Saul failed to disclose material information about the 38 Studios deal to the former Economic Development Corporation’s board of directors and to investors.
Rosen continued, "Today’s filing makes consistent allegations. In addition the SEC issued an order against First Southwest Company today for its conduct in acting as the financial adviser to the former Economic Development Corporation in connection with the 38 Studios transaction. That order concludes that First Southwest committed willful violations of fair dealing requirements of certain federal securities rules. That is also consistent with the allegations in the Commerce Corporation’s lawsuit against First Southwest Company. The Corporation will continue to work toward its goals of recouping money for Rhode Island and holding the defendants in the Commerce Corporation’s lawsuit accountable.”
38 Studios, launched by former Red Sox star Curt Schilling, was lured to Rhode Island with a $75 million state-backed loan guarantee. The company went bankrupt in 2012, leaving taxpayers on the hook at that time for more than $100 million.
According to the SEC release, "The SEC also charged Wells Fargo’s lead banker on the deal, Peter M. Cannava, and two then-RIEDC executives Keith W. Stokes and James Michael Saul with aiding and abetting the fraud. Stokes and Saul agreed to settle the charges without admitting or denying the allegations and must each pay a $25,000 penalty. They are prohibited from participating in any future municipal securities offerings. The SEC’s litigation continues against Cannava, Wells Fargo, and RIEDC."
A lawyer for Cannava told Reuters he considers the allegations to be without merit.
"Municipal issuers and underwriters must provide investors with a clear-eyed view of the risks involved in an economic development project being financed through bond offerings,” Andrew Ceresney, director of the SEC Enforcement Division, said in a statement. “We allege that the RIEDC and Wells Fargo knew that 38 Studios needed an additional $25 million to fund the project yet failed to pass that material information along to bond investors, who were denied a complete financial picture.”
According to the SEC:
"The SEC’s complaint further alleges that Wells Fargo and Cannava misled investors in an additional way in bond offering materials:
- Wells Fargo disclosed its bond offering compensation as a share of the placement agent fee plus a $50,000 payment from 38 Studios. No other fees or compensation to Wells Fargo were disclosed, and the bond placement agreement stated that no other money was anticipated.
- Investors weren’t informed that Wells Fargo had a side deal with 38 Studios that enabled the firm to receive nearly double the amount of compensation disclosed in offering documents.
- This additional compensation, totaling $400,000 and paid from bond proceeds, created a conflict of interest that Wells Fargo should have disclosed to bond investors.
- Cannava was responsible for Wells Fargo’s failure to disclose its additional fees."
The SEC said it used a separate administrative proceeding to settle a case with the RIEDC’s financial advisor for the bond offering, First Southwest Company LLC. The settlement involved charges that First Southwest "violated MSRB rules by failing to document in writing the scope of the services the firm was providing in the bond offering until seven months after the financial advisory relationship began. Without admitting or denying the findings, First Southwest agreed to pay disgorgement of $120,000, prejudgment interest of $22,400, and a penalty of $50,000."
A lawsuit launched by former Governor Lincoln Chafee against Schilling and a number of defendants is scheduled to go to trial in September. Some defendants have chosen to settle rather than go to trial.
In a statement, House Speaker Nicholas Mattiello offered this reaction to the SEC action:
“I would note that the SEC complaint has nothing to do with the General Assembly’s passage of legislation. The focus is clearly on the flawed implementation and execution of the 38 Studios’ bond offering. It is very troubling that the SEC alleges that Wells Fargo was working on both sides of the transactions and did not disclose this information to bond holders. It is also disturbing that the EDC failed to protect the best interests of the state’s taxpayers in this transaction.”
General Treasurer Seth Magaziner offered the following statement:
“The SEC’s fraud charges related to the 38 Studios bond offering illustrates once again the urgent need for stronger debt management and oversight in Rhode Island. My office has taken action to strengthen debt management in Rhode Island, by replacing the financial advisor involved in the 38 Studios deal and introducing legislation to strengthen oversight of public borrowing at all levels of government. I am committed to working with the General Assembly to reform Rhode Island’s system of debt management and oversight, to minimize the chance of a future public debt debacle.”
This post has been updated.